Jonathan Clements has
written The Wall Street Journal's Getting Going personal-finance column
since October 1994. Born in London, Jonathan is a graduate of Emmanuel
College, Cambridge University, where he edited the student newspaper.
He was a writer and researcher for Euromoney magazine in London before
moving to the New York area in 1986. Prior to joining the Journal in
January 1990, he covered mutual funds for Forbes magazine.
Jonathan is the author of "You've Lost It, Now What? How to Beat the
Bear Market and Still Retire on Time," published in 2003. His earlier
books include "25 Myths You've Got to Avoid -- If You Want to Manage
Your Money Right" and "Funding Your Future: The Only Guide to Mutual
Funds You'll Ever Need." He has two children and lives in Metuchen, N.J.
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Yield-Hungry Bond Investors
Have a Risky Option: Stocks November 28, 2007
If you're a bond investor hankering for higher yields, here's a radical suggestion: Try stocks.
Since mid-July, the Dow Jones Industrial Average has
slumped 8%, bounced back 10% and then dropped another 10%, before
rallying 1.7% yesterday.
Yet, if you look beyond the wild stock-price swings, you will find shares are a remarkably reliable source of income.
Want an alternative to 10-year Treasury notes, with their skimpy 3.9% yield? High-yield stocks could be just the ticket.
•Whipping inflation. Suppose you were born at year-end 1925 to affluent parents, who immediately bestowed $1 million upon you.
Let's assume they took the safe route, stashing the
entire sum in Treasury bills and then left you to live off the
interest. In 2006, your income would have been $48,000, versus $33,000
in 1926, according to Ibbotson Associates, a unit of Chicago investment
researchers Morningstar. Trouble is, because of inflation, $1 of
interest in 2006 had less than a tenth of the spending power of $1 in
1926.
Now, imagine instead that your parents rolled the dice
and plunked the $1 million in large-company stocks. If you spent the
dividends but didn't sell any shares, you would have pocketed a robust
stream of income that climbed in 65 years and fell in just 15, Ibbotson
calculates.
Even more impressive, your $1 million would have
ballooned to $111 million over the 81 years -- and your income would
have jumped from $54,000 in 1926 to almost $2 million in 2006. Indeed,
your income would have grown at an average 4.6% a year, easily
outpacing inflation's 3.1%.
•Getting cut. Admittedly, buying
stocks for income has its drawbacks. The broad U.S. market currently
yields less than 2%, so you will need to own high-yield shares if you
want a healthy amount of income.
These high-yield shares are typically beaten-down
"value" stocks. Value stocks, especially small-company value stocks,
held up well through the 2000-2002 bear market and then posted
market-beating gains during the recovery that followed. But in 2007,
the cycle has turned in favor of growth companies -- and thus a
high-dividend strategy could push you into value stocks at just the
wrong time.
Relying on stocks for income will also leave you at
the economy's mercy. "If this advice is wrong, it will be very wrong,"
warns Laurence Siegel, research director in the Ford Foundation's
investment division. "The dividend strategy would be a terrible one if
we had a prolonged economic downturn. During the Great Depression,
companies cut dividends dramatically."
Even if dividends hold up, you will need to shut your
eyes to share-price swings. That's easier said than done. "The
imaginary investor who doesn't care about price probably doesn't
exist," Mr. Siegel says.
•Banking dividends. For
high-yield investors, the ride could prove especially nerve-racking.
The reason: To collect handsome dividends, you often have to buy the
market's least-loved companies.
For instance, financial planner Ross Levin likes high-yield stocks such as Bank of America, U.S. Bancorp, Wachovia and the exchange-traded iShares Dow Jones U.S. Regional Banks
(IAT). "They look extremely cheap," argues Mr. Levin, president of
Accredited Investors in Edina, Minn. "The only problem is, we don't
know whether they'll get cheaper."
Bank stocks could get roiled by more bad news,
including dividend cuts. Still, if you own a basket of these stocks,
you should enjoy bond-like yields, plus your dividends ought to grow
over time. An added bonus: While a bond's yield is dunned at federal
income-tax rates of up to 35%, qualified dividends are taxed at a
maximum 15%.
These funds should yield 4% to 6%. Sound like an
attractive option for retirees? Given the risks, high-dividend stocks
shouldn't be your sole investment. But if you're hunting for more
income in today's low-yield market, they could be a good choice for a
chunk of your portfolio.
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