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 theory (MPT) says 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
- Conclusion
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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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Discussion
i liked the write up. While most of our members probably understood the basic concept, she got down to the nitty/gritty and it helps me to review it. Chasing yield even in the high yield end of the fixed income universe seems RISKY for a 78 year old every time uncle Ben speaks I come to the conclusion that we have a few more years to benefit as long as we are ready to change course when things change.
posted 6 months ago by Patrick Roszel from Kansas
Dividend producng stocks are many different animals. Utilities thrive on low interest and deflationary environment.Pharma is a growth area, staples seem to me to be good in a deflationary and oils in an inflationary. It seems as long as we have business cycles they tend to offset one another. My question is has the fed and ecb outlawed the cycle?
posted 6 months ago by Thomas Wides from Ohio
The article is worth review. I cannot escape the sense that serious inflation is in our future with all the QEs, etc; the onlly question is how soon we must pay the piper.
posted 6 months ago by Thomas Hutchison from Virginia
I have a number of muni bonds, bought years ago, that pay around 4%, and I will hold them to maturity. But I don't see any sense in buying new low-risk bonds like US Treasuries, as long as the yields are below the inflation rate. to what purpose? Currently you will lose purchasing power,and longer range inflation will kill their purchasing power when they mature. I didn't sell many of my stocks during the recent crash, and most came back nicely. But now I only buy stocks with a dividend higher than the inflation rate.
posted 6 months ago by James Bushnell from Florida
I have 100 shares of stock in XYZ company bought at $100 per share. I have automatic reinvestment of my dividends. The company pays $1 in dividends. The price is automatically adjusted down by $1 so the price is now $99. Now I have 101 shares at $99 and $1 left over. After paying taxes I am worse off. Where is the dividend helping me?
posted 5 months ago by Harold Marrett from New York
