How should payouts from investments really be measured? Typically, such pay-outs are thought of as yield: the cash that bonds or stocks currently generate. That is the logical starting point; if one were to calculate only a single payout measure, yield would be it.
It is not, however, the ending point. A successful purchase may increase its payouts over time, while an exceedingly poor one will default, thereby ceasing to produce any payments. The latter case, everyone appreciates. Fear is a highly effective instructor. But the former receives less attention. Many investors who seek payouts do so simply by selecting the highest-yielding security that meets their minimum credit standards. Growth is never a consideration.
That can be a fruitful approach. There is a place in portfolios for high-paying investments that will maintain their distribution rates but not increase them. However, it is not the only way to invest for distributions – and in many cases, not necessarily the best.
Using data from Robert Shiller, comparing the monthly dividend yield for the S&P 500 to the coupon yield on 10-year US government bonds – or Treasuries – over the nine-year period since summer 2009 shows that the two yields have, for the most part, been comparable. So why hold risky stocks, when the same income could be gathered from bonds that allowed one to sleep at night?
The relationship between stock dividend payouts and Treasury yields has changed greatly over time. One would think the two items would be linked, such that when one rose, the other would rise in tandem. Not so. Through the middle of last century, stock dividend rates were routinely higher than Treasury yields; then they declined, so that by the mid-1990s they were far lower.
Volatility Matters
Now, the two live in the same general neighbourhood, albeit with much fluctuation. Whether that volatility is relevant depends on the context. It matters greatly at the entry point. Somebody who invested $100,000 in the 10-year Treasury at the start of this period, July 2009, would have received $3,560 a year. The unfortunate investor who waited 15 months would have got just $2,540. That makes for over a $10,000 difference over the life of the investment. Transactions make volatility meaningful.
The volatility also matters for withdrawals, albeit in reverse. While buying Treasuries in summer 2009 would have created relatively fat payouts, selling them would have resulted in relatively lean receipts. Similarly, investors who held tight in summer 2009 when yields were relatively high, then sold in late 2010 when yields were lower, would have done well. The key item for him should not have been the behaviour of the market, but instead what happened to the numerator.
As it turns out, the numerator takes a much steadier path. The chart below depicts the growth of income for the two investments on a $100,000 initial outlay. There is no growth for the 10-year Treasury. Each year, it pays the aforementioned $3,560. In contrast, the stock market's distribution steadily increases, beginning at $2,674 and finishing at $5,449.
For the nine-year period, the income created by the two strategies was roughly equal. Stock dividends were slightly higher than Treasury-note payments, overall, but as the note's advantage occurred in the early years, the time value of those monies levelled the field. Call the contest a draw. From this point forward, however, things look different.
Stock dividends would need to decline by 40% for the equity investor's income to match that of the Treasury owner, and that is very unlikely. Even the 2008 financial crisis knocked dividends down only by 25% from peak to trough.
It will be protested that I massaged the findings by beginning these charts at the stock market's bottom, thereby making it a nine-year analysis rather than the more-natural 10 years. That is true, but not quite in the manner intended. As previously stated, the behaviour of the stock market was beside the point.
The dividend-income chart that starts in summer 2008 looks much the same. What changes is the Treasury-note yield, which exceeded 4% higher than at any time since. I did not think it reasonable to conduct a study that implicitly assumed perfect investor timing.
John Rekenthaler has been researching the fund industry since 1988. He is a columnist for Morningstar.com. While Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.
