Sunday, June 10, 2012

Why I prefer DG Stocks to Bonds

With today's low interest rates a lot of income seeking investors have switched to DGI. I would like to think that many would be converted to stick with DGI because it offers much more protection in your purchasing power than bonds do. The ultimate goal of investing is to wind up with more purchasing power than you started with at some point in the future. I believe that bond investors will end up severely behind the ball especially with the current low interest rates that treasuries are offering. The 10 year treasury yield is currently 1.63%. We'll assume that the dividend yield is 2.50%although you can get a much better yield from stable companies like KO, JNJ and PG. We'll also assume that the dividends are increased annually at 7.0% and that dividends are not reinvested. Inflation will be taken as 3.00% and $10,000 will be invested in both.

At the end of 10 years you would have received a total of $1,630 in bond payouts and your $10,000 payment back. Great right, you made $1,630. Not so fast our no so good friend inflation has to be taken into account. The $10,000 you locked up for 10 years as well as the $1,630 you received along the way is now only giving you $8,831.36 of purchasing power.

The dividend growth investing approach is much better. You would have received a total of $3,454.11 in dividend payments throughout the 10 years and we'll assume that the stock price didn't move at all and you sold out and got your original $10,000 back like the bond. So in total you cashed out $13,454.11 but we have to take inflation into account along the way. After inflation you would have $10,339.35 worth of purchasing power. So you ended up improving your situation.

Now I'm sure some people might bring up that the difference in yield is what makes the difference and they are partly right. If we start with a 1.63% yield for the DGI approach you would have a total of $12,252.08 worth, after inflation, $9,330.70 in purchasing power. So you lost purchasing power over the decade but you're still better off than the bond investor by $499.34.

Considering that most DG investors have a minimum entry yield criteria, I'm sure you would be starting off at a better yield than the paltry 1.63%. All while being invested in solid companies with a commitment to growing their dividend and rewarding shareholders. I would also bet that you can get a better than 7.00% growth rate.

You could actually drop your starting dividend yield down to 1.20% and thanks to the power of dividend growth breakeven with the bond investment.

This is why I choose dividend growth investing. It offers a steadily rising income stream whereas the bond payments are losing ground every year.

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