The furious search for an income stream in this low-rate environment is leading retirees down an uncertain path. For most of this year, advisers have been talking up blue chip dividend-paying stocks as a substitute for CDs, annuities and bonds. Many of their clients have taken the advise, and so far it’s not working out all that well.
On the surface, swapping low-yield fixed income products for big-company stock dividends seems like a wise move. Government bond funds yield just 2% or so. You can get nearly 4% in a diversified fund that holds dividend-paying stocks and closer to 6% with a single stock like Altria.
Yet stocks and bonds are on opposite ends of the risk spectrum. You have to ask: Is the extra yield worth the wrenching ups and downs of the stock market? Be careful. Your answer today might not be your answer tomorrow. In the real world, retirees with no ability to replenish their assets have a difficult time accepting any hit to their principal even if it may prove fleeting and the dividends keep rolling in.
Anyone who traded safe but low-yielding bonds for dividend stocks this summer is getting a taste of how this strategy can lead to ulcers. The past three months, dividend payers have lost about 5% of their value despite their higher payout.
You may conclude that is an acceptable near-term hit as long as the dividends keep coming. But consider that these stocks are roughly four times more volatile than bonds, according to research from DoubleLine Capital. Even a diversified portfolio of dividend payers could lose 40% or more in a down market. It’s highly unusual for an intermediate-term government bond fund to lose as much as 6% over 12 months.
Now for the real kick in the pants. While dividend stocks have been flat to falling all year, ultra-safe bond investments have been sizzling. Some government bond funds are up 25%. Most other bond categories are up as well, though by a considerably lower margin. So playing it safe has paid off in a good night’s sleep as well as in a better total return.
What about going forward? Don’t be shocked if bonds continue to outperform. If the economy slumps again, already low government bond yields could go even lower as bond prices rise and more than compensate for their stingy yields. That’s not a lock. So it may be little comfort to retirees trying to match fixed income with fixed expenses. “But you don’t have to risk going all the way into stocks,” says Jeffrey Gundlach, CEO of DoubleLine. If you must boost your income, he says, you can do it with far less risk than dividend-paying stocks. A mixed bag of bond funds that invest in government securities, mortgages, investment grade corporate and emerging market debt, and junk bonds can easily produce reasonably reliable income of around 6%.