Total Return vs. High Yield Investing
Investors are long in favor of dividend and interest paying securities. In a balanced portfolio, that means (high) dividend paying stocks and (high) interest paying bonds. In old days, stocks that paid healthy 5-10% dividends were often called widow stocks as many old widows would just rely on dividends or coupons to fund their daily spending. Examples are Williams Companies (WMB) (current dividend 3.4%) or AT&T (T) (current dividend 5%). Unfortunately, in today’s extremely low interest rate and generally expensive stock valuation environment, it is hard to build a solid stock portfolio that yields 5% or so, it is even harder to build a balanced stock and bond portfolio that yields this high. Currently, for example, on stock side, S&P 500 SPDR SPY yields 2.08% while on bond side, Total Bond Market Index BND yields 2.23%. It is thus fair to say on average, a reasonable portfolio yields approximately around 2%, a far cry from 5% or higher.
High yield oriented investing are popular among retirees or income oriented investors. The following are the main reasons often cited:
- A high yield portfolio generates a steady stream of cash without needing to sell a security, giving investors a sense of ‘income’.
- If dividends received are ‘qualified’ dividends, they are still taxed at a low 15% rate for annual income up to $400,000 ($450,000 for joint filers). This is compared with capital gain tax that can be as high as ordinary income tax.
- In general, stocks paying dividends are more reliable and they produce better returns with less risk in the long term. This argument has a qualification which we will discuss shortly.
As we detailed in May 6, 2013: High Dividend ETF Portfolio Construction, there are the several classes of high yielding stocks or bonds:
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