Two Alternatives To Low-Yielding Bonds
May 31, 2016
by David Miller
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Loose monetary policy and uncertainty about future Fed rate hikes have made the quest for higher yield fraught with risk. With the expectation of lower 10-year Treasury yields, it’s clear that the current environment will persist and bonds will not yield the same low-risk returns they once did. But investors – especially those in or nearing retirement – have two choices to bolster portfolio performance.
This low-interest rate environment is challenging for portfolios that rely heavily on conservative, reliable asset classes. Bonds represent a vital component of these allocation strategies, particularly for clients with a small appetite for risk. This is especially relevant for investors nearing retirement, who often prefer heavier weighting towards bonds in order to secure consistent, low-volatility returns. But near-zero returns are depriving investors of additional money for retirement.
While the current equity bull market gives credence to the notion that capital growth is superior to income, more recent market declines have reminded investors that a focus on both income and capital appreciation is a better approach to generating stable returns. In this lackluster bond market, here are alternative options that will generate meaningful returns without taking on additional risks:
Low-Yielding Bonds – Dividend stocks
Dividend paying stocks are the most obvious option. Over the long term, dividends have proven to be a meaningful source of stock market returns. While many investors do not intuitively associate equity income with capital appreciation, dividends have proven to be a powerful element of building wealth, especially during periods of negative equity returns. Beyond providing a “cushion” in falling markets, dividends create an opportunity to accelerate and magnify a portfolio’s recovery. Through the reinvestment of dividends, investors are able to capitalize on falling equity markets by accumulating additional shares at lower equity prices without investing additional capital. This principle has a powerful effect on long-term growth.
Dividend payments are a straightforward and effective tool to identify quality, well-run companies. A management team’s commitment to distribute a portion of earnings to its shareholders through dividends not only requires a disciplined and efficient approach to capital allocation, but it also signals to the market that management is confident in the current and future health of the company. Furthermore, unlike evaluating a company based on earnings or profits – which varies based on management accounting choices – dividends are paid to an investor in cash and not subject to estimation, manipulation or creative accounting.