Let’s face it, income investing can be a challenge these days. With the Federal Reserve on record as saying it intends to keep the Federal Funds rate at zero for another 18 months or so, buying treasuries is a losing proposition. Even if you venture all the way out to a 10-year note, the 2 percent yield isn’t keeping pace with inflation (currently running at more than 3 percent.)
One workaround to the negative real returns on treasuries is to tilt your income portfolio more heavily into high-grade corporate bonds. OK, those aren’t exactly overflowing with income, either — they pay about 2 percent more on average than treasuries, but that just means you’re often locking in a fixed yield of just 3 to 4 percent.
Some appealing blue chips
The better play could be to skip the bond of many blue chips and invest in its stock instead. It turns out plenty of classic high-quality blue chip U.S. stocks have stock dividend yields higher than what they’re paying on their bonds. For example, this past summer PepsiCo (PEP) floated short-term bonds with yields under 2 percent, while the current dividend yield on PepsiCo stock is 3.2 percent. Over at Johnson & Johnson (JNJ), bonds maturing in 2019 have a yield to maturity under 3 percent, while JNJ’s dividend yield is 3.6 percent.
- Johnson & Johnson
- Procter & Gamble
Same sort of story at Procter & Gamble, (PG) where the 3.2 percent dividend yield beats out what most of its bonds pay. Microsoft’s 3.1 percent yield (MSFT) exceeds the payout on its bonds with maturities out past 20 years. In a recent Wall Street Journal commentary, Burton Malkiel, professor emeritus at Princeton and author of the classic A Random Walk Down Wall Street, pointed out that the dividend yield on AT&T (ATT) stock is nearly double the interest payout on its 10-year bonds.
You get the idea. For income seekers in the corporate arena, it’s the stock dividend — not the bond — that should get your attention.
[quote]One benefit of a dividend-based income strategy is that if you cozy up to a company with a history of raising its dividend, you’re effectively creating an income stream that has a shot at keeping pace with inflation.[/quote] Now of course stocks are a helluva lot more volatile than bonds. No getting around that. Rather than high-tail it outta bonds and into dividend-paying stocks, what makes most sense is to take a look at how your existing allocation to stocks might be tweaked to take on more income-producing duties for your overall portfolio. As Marilyn Cohen, founder of Envision Capital Management, put it to me: “If you’re not getting income from your stock portfolio, shame on you.” And her firm specializes in bonds.
An added benefit of a dividend-based income strategy is that if you cozy up to a company with a history of raising its dividend, you’re effectively creating an income stream that has a shot at keeping pace with inflation. Can’t say that about a fixed-income bond payout.
The $7.9 billion SPDR S&P Dividend ETF (SDY) trawls the S&P 1500 index for companies that have managed to increase their dividends for at least 25 consecutive years. There are also plenty of actively managed funds that focus on stocks of firms that are poised to increase their dividends, such as Vanguard Dividend Growth (VDIGX). Or you can, of course, build your own portfolio of individual stocks that deliver dividend income. For the patient, long-term investor, over time, you’re not only pocketing the dividend, but you also have the prospect of capital appreciation as well. That’s doubly compelling in today’s world, where treasury yields of 1 to 2 percent lock you into inflation-lagging yields.
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