Publication: Investor's Notebook
YOU SHOULDNT INVEST IN DIVIDENDS ALONE | |
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Investor's Insight - February 20, 2006
"A Digest of Investment Opinion From the
World's Leading Financial Advisers"
Comment The Post Below...
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YOU SHOULDN'T INVEST IN DIVIDENDS ALONE
by Scott Burns
Q: What is your opinion of a retirement plan that would
consist entirely of investments in high-dividend-yield
stocks, aiming for a dividend yield of 3.5 percent to 4
percent? The dividend income would be used to pay living
expenses. There would seldom be any need to sell shares
-- unless there was a significant problem with the company
(e.g., Ford, GM). Shares sold would be replaced by other
names. Over the long run, 25 to 30 years, would this app-
roach be safe, and would it beat the 50 percent stocks, 50
percent bonds of the Couch Potato portfolio? -- S.T., Dallas
A: In the late '70s this was called a "yield tilt" strategy.
Today it is most commonly seen in "equity-income" funds that
attempt to provide a dividend yield greater than the S&P 500
index. I admire this approach and think it is particularly
useful for retirees.
The greatest losses happen when we are forced to sell assets
to meet income needs -- so the more you can do to have your
investments provide all the cash income you need, the better.
This, by the way, is the reason portfolio survival for any
given income rate can be improved by buying a life annuity
with a portion of your savings.
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The greatest danger in a high-yield stock portfolio is that
it will be concentrated in a few industries. Banks are among
the top dividend payers today, along with REITs, some elect-
ric utilities, the tobacco companies and a few pharmaceutical
companies. Less diversification means more risk.
Another danger is that you can lose a great deal of money if
you are forced to sell stocks to pay for an illness or other
disaster. The only thing you can be certain of is that your
personal disaster will happen during a period of falling
stock prices, not rising stock prices.
So you won't find me endorsing a 100 percent stock portfolio.
As a source of protection and diversification you should con-
sider an 80/20 stock/fixed-income portfolio with the bonds
invested in a five-year ladder of Treasury notes. The ladder
will provide you with a minimal-risk source of emergency funds
and a relatively good yield. With yields on one- to five-year
Treasurys now around 4 percent, it would meet your income re-
quirement as well.
Q: Do you subscribe to the notion that the higher than normal
price-to-earnings (P/E) ratios the stock market has been ex-
periencing are due, in part, to U.S. demographics? In other
words, are baby boomers' savings driving up P/E ratios, and
will things shift downward in the next 10 years as boomers
shift out of stocks? If so, are you aware of any solid foreign
markets to invest in with demographics that run counter to the
U.S.? -- M.G., by e-mail
A: The two largest levers on common stock prices are interest
rates and inflation expectations. As interest rates and infla-
tion rose in the '70s, for instance, investors were willing
to pay less for a dollar of corporate earnings because there
was more competition from the bond market. In addition, the
price of growth stocks was hit hard because most of their
earnings are in the future. The greater the rate of inflation,
the greater the value of dollars received today relative to
dollars expected in the future.
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As interest rates and inflation peaked in the early '80s,
stocks sold at only eight times trailing earnings. Dividend
yields were well over 4 percent. The bull market we've exper-
ienced since then has ridden on the back of declining inter-
est rates, not demography. Today, we're in the reverse situ-
ation: Both interest rates and inflation are low -- so stocks
are selling at high multiples of current earnings.
One of the ironies of the current concern about Social Sec-
urity and Medicare is that the United States compares well
with the profoundly dismal demographic realities in most of
the world.
Don't get me wrong: It's a matter of proportion. Our prob-
lems are huge, but demographic problems in the rest of the
world are gigantic. Our demographics are milk and honey
compared to Europe and the former Soviet Union. Japan may
be the fastest-aging nation on the planet. And China has
both an aging problem and a catastrophic imbalance between
their population of young men and young women.
We should never forget that this is the best "problem" human
beings have ever faced -- living "too long."
(Investor's Insight reflects the opinions of experts. It does
not recommend any specific investments, and no endorsement is
implied or should be inferred. For more information, contact
the individual firms cited).
COPYRIGHT 2006 UNIVERSAL PRESS SYNDICATE
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END OF INVESTOR'S INSIGHT
Copyright 2006 by PENN LLC. All rights reserved.
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