Value Investing / Main Index / previous / next

July, 2017


Both bonds and stocks can provide income. An advantage bonds have is that in rough times for stocks they tend to hold their market value relatively well. Thus, if one wishes to have more portfolio stability during inevitable bear markets for equities, a healthy percentage holding of bonds can be reassuring. In the 2007-2009 market tumble, a blend of 40% bonds and 60% stocks, fell about 32%, whereas the S&P 500 Index alone fell over 54%. A September 4, 2007, $100,000 investment in a 40/60 mix of Vanguard Total Bond Market Index Fund, Investor Shares (VBMFX), and Vanguard 500 Index Fund, Investor Shares (VFINX), would have been worth $67,523 by 3/9/2009, whereas an all-equity investment on 9/4/2007 in the Vanguard 500 Index Fund, Investor Shares, over the same period would then have been worth only $45,537, an extra loss of $21,986 or 21.99% of the original investment.

Nonetheless, a case can be made for obtaining most of one's income from stocks instead of bonds. To paraphrase Warren Buffett, I would rather have a bumpy 15% annual return than a smooth 12%. And the fact is that bonds do not keep up with inflation, whereas stocks do. What is more, these days the yield or income from bonds other than high risk ones is often even lower than that for good quality, large-capitalization stocks. In addition, bonds, even if kept to maturity, generally only provide back to the investor the amount that was originally invested, though this can vary according to the type of bond. Stocks, on the other hand, have significant potential for price appreciation over time. If I focus on the income I am receiving from stocks as a whole and not on their volatility or likelihood of going up or down respectively in bull vs. bear markets, then stocks are certainly preferable in most instances.

Imagine a person who does not need to dip into the stocks he or she owns for living expenses and plans to never sell a portfolio, but instead can simply rely upon its dividend income. That person can look on the ups and downs of the equity market as like the passage of the seasons in their effects on an outdoor garden. In a temperate climate zone without a greenhouse, there will of course be periods when things do not look particularly good for the garden, and it may appear even beyond hope for awhile. Yet, each spring the gardener, aided by solar energy, water, and good soil, can encourage new growth until within a few weeks or months there is a fresh bounty of produce, the equivalent of one's stock portfolio income, produce that is predictable and independent of the ravages of many severe autumn and winter conditions.

Now consider the amount of that "produce." In almost all markets there are at least a few good quality stocks that provide dividends competitive with the yields of bonds. Today is no exception. It is no trouble to find stocks with excellent financial strength, growth potential, and sizable dividends even when compared with bonds.

Here are examples:

Chevron Corp.CVX$104.414.15%
Cisco SystemsCSCO$31.423.71%
Qualcomm, Inc.QCOM$56.814.06%
Total, ADRTOT$49.665.40%
Verizon CommunicationsVZ$43.565.31%

One can add to income equities on a regular basis, perhaps every 3-6 months, each time seeking the best risk-adjusted value. Even among top-notch companies there are almost always some temporarily in the doghouse whose dividend percentages (of the cost basis) benefit as a result. My current favorites of this sort are Total, ADR (TOT) and Verizon Communications (VZ).

Since even fairly mature, conservative, large-cap stocks tend to go up in value and price over time, whereas bonds typically do not, there are excess profit advantages to owning income stocks over bonds. These extra profits, in turn, are frequently passed along to shareholders via increases in the dividend amounts. Thus a 4% dividend yield at the time of a stock's purchase can become in ten or fifteen years a 6% or even an 8% yield, in relation to the original purchase price (the yield-on-cost). On occasion, the effects of these increases are stunning. CocaCola (KO) paid a 3% dividend in 1988, the year Warren Buffett bought a large number of shares for Berkshire Hathaway. Because of the company's profitability, subsequent increases in the asset's return to shareholders, and stock splits or buybacks that have improved the value of each remaining share, the yield-on-cost of his original purchases is now over 50%.

I began buying higher dividend stocks, beginning with AT&T (T) in order to offset added costs of our phone, wifi, and internet services. Recently I realized that of course other high quality companies' shares could enhance our overall dividend income. Ideally, investments can help assure such income increases annually, whether or not we are in a bull market. Dividends from stable companies are better than most annuities in the sense of providing not only good yields but overall growth in annual returns. As we now approach in the life of Riley the number of years I worked for Disability Determination, our annual dividend income exceeds each year's state retirement checks. Indeed, those checks have not been increased to adjust for inflation or health care deductions, so their buying power has steadily gone down, currently only about 60% as valuable as when I left regular employment. Yet the dividend income has persistently risen, even outpacing medical and other inflationary factors. This should continue whether stocks are up or down.

The downside, as noted in the opening paragraph, is not to be discounted, however. If one is liable to need to use nest egg assets beyond their dividends to pay for expenses or settle an estate in the next few years, then money market funds, certificates of deposit, and short-term Treasuries are probably a better place to park one's liquid assets. Alternatively, one can seek a cautious blend, for instance, of cash reserves, bonds, annuities, real estate, and stocks (or stock mutual funds) and at times rebalance the allocation's mix to restore the intended percentages in each.


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)

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