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Saturday, April 27, 2013

Dividends vs. Bond Yields

Dividend Payers vs. Bonds
The battle between dividends and bond yields rages on.  Times are atypical.  Typically, a bond allocation can easily be met by buying a well-diversified portfolio of bonds tracking the overall market--an ETF that tracks the Barclay's Aggregate Index, such as AGG or SCHZ.

But today the 10-year Treasury note yields 1.7% and high risk bonds trade at historically low-yield spreads.  Furthermore, investors are becoming more aware of bond market risks.  They are more aware of falling prices as yields rise, and junk bonds facing yield spread widening risk in the event the economy surprises on the downside.

Understandably, investors, including especially those in retirement or close to retirement, are looking around.  Stocks with dividend payouts exceeding the yields on their bonds have caught their eye.

Not only are investors using dividend stocks in the stock allocation portion of the portfolio, they are also substituting dividend stocks for fixed income.  The thought here is to forget about price and focus on dividend yield.  Hold for the long run and seek issues with a history of raising the dividend.  **Think about this:  if you have $1.0 million and need $30,000/year, then a portfolio of stocks that paid 3% and had a history of raising dividends might be interesting to consider.  Along these lines, how would one find such a listing?

Today this is actually quite easy to do, given the excellent research and writings of dividend bloggers. Here is a recent posting by Dividend Growth Investor, one of the best in this genre:  "Dividend Investing Articles to Enjoy."  In the post, the first article contains a favorite listing by Dave Fish which has an Excel spread sheet listing companies with at least 25 years of increasing dividends.  This is an excellent source for dividend investors.

You'll also want to read the article from Dividend Ninja's site on why dividend stocks are not bond substitutes.  This, obviously, argues against the view up for consideration here; but it is good to consider different points of view.

In fact, I would argue for thinking about over-allocating to the stock allocation by 10% (for example, if the allocation is 60% stocks, make it 70%) with strong dividend payers and under-allocating by the same 10% to the fixed income portion.

**There are two ways to construct a portfolio.  The predominant way is with a view towards beating the market in terms of total return.  The second way, that is little discussed but seems to be a driving force among those building dividend portfolios, is to construct a portfolio to yield a given income stream with little thought to the price movement of the assets - especially over the short term.

Disclosure:  Investors should do their own research or consult a professional before making investment decisions.  The information here is for educational purposes.

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