The recent stock market correction has made stock yields much more attractive. Dividend yields have returned to higher levels and the Dow now yields more than 10 year treasury bonds.
. . .one good estimate puts the dividend yield on the Dow at 3.1%, while Eddy Elfenbein has calculated it to be 2.9%. Either way, it’s higher than the current yield on the benchmark U.S. Treasury bond, which was last seen at 2.89% and falling.
When investing risk and reward are closely related. Therefore, this Dow vs treasuries comparison gives us some insight into the potential future returns of the two asset classes.
Future Bond Returns
High-quality bond returns are primarily a function of their yield and with treasury yields near all time lows, bonds are likely to produce low returns going forward. In addition, since interest rates cannot go any lower we face the risk that bond prices will decline with a rise in interest rates. For these low-risk investments, the future returns don’t look good.
Future Stock (Equity) Returns
Contrastingly, stocks are producing relatively high yields when compared to treasuries. When you factor in the tax benefit of dividends over taxable bond yields, the case for stocks outperforming bonds in the future becomes even stronger. Furthermore, historical precedent for holding high-yielding stocks is quite strong:
The annualized rate of growth since 1871 is 1.94%. If that seems incredibly low, remember that the chart shows “real” price growth, excluding inflation and dividends. If we factor in the dividend yield, we get an annualized return of 6.61%.
If we added in the value lost from inflation, the “nominal” annualized return comes to 8.83% — the number commonly reported in the popular press. But for an accurate view of the purchasing power of our returns, we’ll stick to “real” numbers.
Wharton Professor Jeremy Siegel and Yale Professor Robert Shiller have both done considerable work on the historical returns of the equity markets and the impact of dividends on those returns. Their work is the basis for my belief that investors should consider paying less attention to the daily price fluctuations and more attention to the yield of their portfolio. Unfortunately for investors, it is uncomfortable (or risky) to hold stocks and they are tired of watching their life savings go up and down. Owning high-dividend stocks and focusing on the yields can help investors overcome the psychological challenge of being an owner of a highly volatile asset like stocks.
Why Own Stocks Today?
1) Dividend yields are attractive.
2) Dividend yields are likely to increase as the economy recovers over the next five years.
Investors need to remind themselves that historically a large percentage of stock returns comes from the dividends they pay, not price appreciation. To help get through these markets, you may want to consider paying more attention to the yield on your stock portfolio and less to the daily value. Here is a list of high dividend index funds:
High Dividend Index Funds (ETFs/ETNs)
|Strategy||Ticker||Yield||Exp. Ratio||Asset Class|
|PowerShares Listed Private Equity ETF||PSP||5.58%||0.60%||Global Small Cap Value|
|Vanguard REIT Index ETF||VNQ||4.08%||0.13%||US Real Estate|
|SPDR Dow Jones Intl Real Estate ETF||RWX||3.66%||0.59%||Non US Real Estate|
|JPMorgan Alerian MLP ETN||AMJ||5.83%||0.85%||US Mid Cap Value|
|WisdomTree Total Dividend ETF||DTD||3.49%||0.28%||US Multi Cap Value|
|Vanguard High Dividend Yield Index ETF||VYM||3.12%||0.20%||US Large Cap Value|
|WisdomTree DEFA Fund ETF||DWM||8.45%||0.48%||Non-US Multi Cap Value|
|iShares MSCI EAFE Value Index ETF||EFV||4.46%||0.40%||Non-US Multi Cap Value|
|WisdomTree Emerging Mkts Income ETF||DEM||6.56%||0.63%||EM Multi Cap Value|
Data source: WSJ.com, Wall Street Journal data as of July 4th 2010. The advisor holds the following positions: PSP, VNQ, RWX, AMJ, DTD, DWM, DEM.