Stocks vs. Bonds: Why and When?
by Jason Brady
There are many different sources of information about the benefits and limitations of asset allocation.
Effectively, when individuals or professionals try to put together a portfolio, the question of “how much should I own of what?” is often a crucial first step. However, increasingly investors are focusing on goals beyond or in addition to total return. One of the tenets of modern portfolio theorysays that in a frictionless world (no taxes, transaction costs, etc.), investors shouldn’t care about the source of their return and that income (dividends, bond coupons, etc.) is the same as capital appreciation (price movement).
In this article
- Portfolio Allocation and Income-Producing Investments
- Similarities and Differences
- Balancing Safety and Income
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Portfolio Allocation and Income-Producing Investments
In the messy world of actually putting money to work in the marketplace, however, investors have generally moved beyond a world where individual assets are found along a so-called “efficient frontier.” Increasingly, investors are looking for solutions to specific problems, which may or may not include an asset allocation framework dictated by MPT. One of those problems is that of finding income. As demographics globally move toward a greater proportion of older individuals in developed markets, and expected life spans get longer, the need and desire for income-producing investments has increased dramatically. This is, in my view, part of the reason why many of those same developed markets have tiny “risk-free” rates of return. The income available from very low credit-risk instruments such as U.S. Treasuries and German bunds is at historic lows.
A growing body of theoretical and practical research also has highlighted the benefit of dividend-paying stocks as both an attractive total return option as well as a source of income return. Dividend-paying stocks tend to grow their earnings per share over time faster than non-dividend payers. This is quite counterintuitive (how is it possible to give away more, reinvest less, but then make more?), but is a key component to the overall strong returns of dividend payers over time.
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