Money funds and certificates of deposit continue to pay woefully low yields of less than 1 percent. Ten-year government bonds pay just over 2 percent and carry temporary price risk if interest rates were to rise. None of this is likely to change much in the next year or two with the Federal Reserve Governors advising that they anticipate keeping the short-term rates they control at very low levels into 2013.
Very quietly, equities have moved into a position of providing very attractive yields relative to traditional savings vehicles and may offer some advantages over time in some situations. For example, the yield on the S&P 500 Index is presently just over 2 percent, roughly the same as offered by the 10-year treasury bond referenced above. Now there is certainly more risk of price volatility associated with a basket of stocks compared to an obligation of the U.S. Treasury, but the question may be one of perspective.
If an investor can put up with the ups and downs of the inevitable cycle of fear and greed, which has always existed in the stock market, and trust that "USA Incorporated" isn't going out of business, then the case could be made that owing stocks for income is a better bet that owning treasury bonds, which only yield 2 percent at present. Of course, one needs to account for the aforementioned volatility, and you certainly wouldn't want to park your emergency cash reserve money in stocks which could decline in value right around the time you may need to use those funds.
But, buying high quality companies with a long track record of paying and increasing their dividend payment to shareholders doesn't have to be viewed as a trip to Las Vegas either. For example (and this is not a recommendation), there are four large companies that hold a triple A credit rating, meaning they are financially very strong and currently rated higher than the U.S. government. The companies are Automated Data Processing, Johnson & Johnson, Exxon Mobil, and Microsoft.
The average dividend yield of these four companies is currently 2.9 percent, or about a third higher than the current 10-year treasury bond yield. Moreover, each of these companies has been increasing its dividend each year, providing an increasing income stream to shareholders. Owning just four companies is not enough diversification for most investors, and these are presented as an example of highly rated companies that could be valuable income producers.
Some stocks yield higher levels of dividends with many providing yields of over 5 percent. Some of these are more stagnant companies in terms of their growth rate, and tend to not increase their dividend as aggressively. So there are two approaches here:
1) Go for more yield now, but with a lower rate of increase in the future.
2) Settle for a little less yield now, but with the chance that the income rate will grow and eventually surpass that of the more stagnant dividend paying portfolio.
I personally favor the second option, especially for those planning a portfolio income program which will be in place for 10 to 20 years or longer. As identified above, the investor must be willing to put up with the inevitable bouts of temporary market volatility which seem to strike every few years for this concept to work. One advantage is that historically, stocks that pay dividends tend to be less volatile that those that do not. Also, remember that diversification across a sufficient number of companies is important for safety. Generally at least 20 positions should be held, if not more.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.