Read of the Day: Dividend Stocks are not an Equal Alternative to Bonds

It’s about time someone wrote this post.  We’ve heard so much in recent years about how low interest rates in fixed income are a good excuse to pile into dividend paying stocks.  As if they’re somehow similar asset classes.  That’s just patently false.  The most destructive comparison is the direct comparison between dividend paying stocks and US Government bonds.  US Government debt is a risk free asset or extremely low risk asset whose income stream  is derived from the most powerful entity on the planet’s ability to tax the most abundant output in the world (of course there is inflation risk, but that’s very different from solvency risk or the likelihood of being made “whole” at maturity).  Equities, on the other hand, represent some of the riskiest assets in the world and derive income over the course of an unreliable and indefinite lifetime.

Anyhow, The Wealth Effect blog has a nice summary of the similarities and important differences:

Here is how I view the similarities and differences between Dividend Paying Stocks and Bonds.

Similarities:

  • Both generate income in a predictable manner (quarterly, semi-annually, etc.).
  • Both require the company to either have cash (profits or reserves) or access to cash (lines of credit) in order to generate the income.

Differences

  • The price of stocks, even dividend paying stocks, generally move more both up and down than bonds. This offers the potential for greater profits but also the potential for greater losses.
  • Stock prices move everyday and there is no point in the future you can point to and know exactly what the price will be whereas barring bankruptcy or other major financial problems, bonds will be redeemed at face value at their maturity date.
  • Income earned as dividends from stocks and income earned as interest from bonds has at times been taxed differently.
  • Dividends can be increased or decreased at the company’s discretion.
    • According to the latest update (October 2012) from the Standard & Poor’s Dividend Report of the over 3,000 dividend paying stocks that trade on major U.S. stock exchanges.
      • 1447 companies have raised their dividends during 2012
      • 124 companies have lowered their dividends during 2012

 

Read more here.

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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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