Equities may be the income source of the future

October 16, 2012 

I get a bit nervous when an investment theme becomes to popular, and there has been no shortage lately of advice touting dividend paying equities as a great idea. However, since this advise is not being rendered with a "get rich quick" tone, I think it is worth examining the concept of using equities as an income source with bond yields likely to remain low for some time.

The concept is not new. For the better part of the 20th Century, until about 1958, stocks in general paid dividend yields that were higher than the yield on government bonds. For the next 50 years, investing in stocks became more of a growth theme and less focus was placed on dividends by both investors and the companies themselves. For much of the last four years, we have again observed the general yield on stocks, presently about 2.2 percent for the S&P 500 Index compare favorably with the recent 10 year Treasury bond yield

of around 1.7 percent.

But, the analysis of the current yield relationship is hardly the whole story as there are other important factors for investors to consider. It is obvious to most that equities carry more fluctuation risk than bonds, especially in the short run. Additionally, businesses sometimes go out of business, and in the case of bankruptcy equity investors usually incur a total loss of the capital invested. The risk of loss of this type can be minimized by owning a diversified portfolio of higher quality companies where any one position is just a small portion of your portfolio.

Government bonds carry the guarantee of the issuing government and in the case of the United States, are considered the safest securities in the world for guarding against a default which would result in the investor receiving less than face value when the bond matures.

But, that doesn't mean that investing in high quality bonds doesn't carry other risks. Bonds fluctuate in value as the prevailing level of interest rates moves up and down. Over the last 30 years, the direction of rates has been lower, from the very high levels of the early 1980s to today's ultra-low rate environment.

This decline in yields has been like a strong wind in the sails of bond investors, providing way above average performance. But, this trend is not likely to repeat itself in the next 30 years from the current low levels. More importantly, if rates reverse course and begin to rise at some point in the future, bond investors could, at least temporarily, see principal value losses which are much greater than the income they are receiving on their 10 year Treasury bonds, presently paying only 1.7 percent.

So, while bonds are an important part of a diversified portfolio, the time may be right to examine equities as income vehicles. Investors able to look past the inevitable short-term fluctuation of stock prices may find that quality companies which raise their dividend on a regular basis may compare favorably to low yielding fixed income vehicles over the next 10-20 years.

Tom Breiter, president of Breiter Capital Management, Inc., can be reached at 941-778-1900 or by email at tom@breitercapital.com.

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