Fool.com: Think Dividend Stocks, Not Bonds [Commentary] January 24, 2005
I ran across this article from TMF. Before I get into it, let me say that the author, Matthew Emmert knows more than any of the other full time people at TMF.
I believe he is wrong in this article which if I read it right is saying that investors implementing a new portfolio should own no bonds. That you should own dividend paying stocks instead. Yikes.
His assertion that bonds may lag dividend paying stock may be correct and I would be inclined to agree with about that. From a portfolio construction stand point, his idea is flawed. He notes that short term yields are not great and that longer term rates are even worse. There are ways to get some yield, for that part of your portfolio, without owning stocks. If you follow Mr. Emmert's advice and stocks tank for some reason, you can bet that dividend paying stocks will participate to some degree in a down turn, much more so than bonds might. In fact an event driven selloff might actually cause a rally in bonds.
People own bonds, among other reasons, to contain risk. When a portfolio that should own bonds, owns 100% equities the risk taken ratchets up dramatically.
He is a very good stock picker but this article misses the mark for portfolio construction.
To be clear, I am still overweight dividend paying stocks, but that is in the equity component of client portfolios, not the fixed income portion. This is an important distinction.
I will forward this post to Mr. Emmert and give him the chance to respond. Could be interesting!
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2 comments:
Funny, I've been thinking about bonds for several day's now. Since you bring it up, I have a question. I agree with you that removing bonds from the portfolio misses the point of including bonds. My question has to do with what the mix of bonds should be... How much should be muni, international, government, and corperate? Do you know of a good resource for determining the proper mix?
I know that I should lean toward short term in a rising rate environment, it's determining the rest of it that I'm not sure of.
Thanks!
Hi Roger,
First, thank you for the very kind words in your post.
On the points in your post regarding my article, I would offer the following:
I believe I was actually a bit more specific in the article than you denote, as I clearly stated that Treasury bonds are the least compelling option in the bond world right now, not all bonds. I further stated that -- even so -- TIPS still present a reasonable return potential in that universe.
However, you're absolutely right in that my main point in the piece was that dividend-paying stocks do represent a better option than most bonds, for most investors, right now (the "most" term must be stipulated, as certainly you recognize the limitations of addressing a broad class of investors within a 1,000 word article).
Your statement that bonds are -- by default -- always less risky than stocks (specifically dividend-paying stocks), and that they are automatically the choice for those seeking safety is exactly the kind of flawed logic that I was attempting to negate with this article.
Indeed, what's so safe about a 0% return, no matter the level of stability that one experiences along the way to that return? My point is simply that substandard returns pose a material risk in their own right, and in my opinion investors looking at long-term bonds (particularly Treasuries) are facing such returns. Though admittedly this is just a single example to demonstrate my point, I would say that the chart at the following link could give one an idea of the "risk" of investing in bonds over stocks for longer time periods that I'm talking about:
http://tinyurl.com/4oslo
Again, certainly there will always be individual opportunities to make money within any asset class and any market. But taken as a whole, current yields represent a poor risk/reward trade off in my opinion.
Your statements also seem to suggest that stocks and bonds never move together, or that bonds always posses less price risk in a down market than stocks, yet this is not always the case. Bond and stock prices have been highly correlated over many periods, as they are often affected by the same things (i.e., neither bonds nor stocks favor inflation or higher interest rates).
So, yes, in this specific environment, I'm saying that there are many, many cases where investors would be better off buying high-quality, dividend-paying stocks as opposed to bonds. Clearly, the factors that influence this decision can change very quickly (as they did back in April and May of 2004 when yields went substantially higher on initial interest-rate fears), and if that happened I would alter my recommendation to reflect the change. However, again, if I had money to put to work right now, today, that money would be in high-quality dividend payers, not bonds.
Wish you continued success with your business and the site.
Foolish best,
Mathew Emmert (TMFGambit)
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