Investing: Juicy Yields

4 minute read
Daniel Kadlec

Alan Greenspan may yet save the world economy with his barrage of interest-rate cuts. But the Federal Reserve’s war on hard times is claiming heavy casualties among conservative investors who have seen their fixed income wither away. With money-market mutual funds now yielding close to 0% after fees and taxes, these investors face some tough choices. But one they might not have considered before–stocks that pay dividends–is looking better every day.

The economy is slowly recovering, making stock dividends more secure. And companies from Microsoft to Tiffany are initiating or boosting dividends to take advantage of new laws that apply the same tax rate to income from dividends and capital gains–just 15%, down from the previous top marginal rate of 38.6% on dividends.

Responding to the favorable tax treatment, 96 companies initiated or raised dividends in June–10% more than in June of last year and a 32% jump over the 10-year average for that month. A handful of blue-chip companies, including Bank of America, Citigroup, Colgate-Palmolive, Goldman Sachs and Starwood Hotels, boosted their dividends a whopping 30% or more. Some smaller firms have been even more aggressive. Energy company Kinder Morgan has a volatile dividend history but recently raised its annual payout to $1.60 a share–five times what it paid last year and double its biggest dividend in the past decade. Corus Bankshares, which has nudged up its dividend for 23 consecutive years, last month tripled the annual payout to $2 a share and now sports a 4% yield–more than double the average dividend yield of 1.6%.

Stocks that have higher than average dividends and that are rated as secure by Standard & Poor’s include AmSouth Bancorp (4%), Chubb (2.4%), Johnson & Johnson (1.8%) and Pfizer (1.8%). These numbers may not seem big enough to lure you back into stocks. But a big advantage of dividends is that they grow over time. An investor who bought Johnson & Johnson 10 years ago would today be receiving a yield of 9% on that initial investment; for Pfizer the yield would be 11%. That investor would also have seen her J&J stock appreciate 90% and her Pfizer 580%.

The trend toward more generous stock dividends gives income-oriented investors a solid alternative to Treasury bonds now yielding under 4%–and dividend stocks are less risky to boot. As the economy recovers, the yield on T bonds (and highly rated corporate bonds too) will rise, driving down the value of existing bonds. “Over the next few years, this is where people will lose the most money in the market,” warns Steve Mintz, a fee-only investment manager in Monroe, La. High-yield corporate junk bonds, though, are somewhat insulated because a stronger economy removes much of their risk. So investors do not demand significantly higher yields.

Scott Kahan, president of the advisory firm Financial Asset Management in New York City, says dividend-paying stocks are a good way to get back into the equity market, if that’s an investor’s goal. But they are no substitute for secure interest-bearing investments. He is worried that the recovery might stall and stock prices tumble. But he is waving clients off money-market funds. “You’ve been losing money in these funds the past six months if you own them, as many people do, in a variable annuity,” where expenses may be double the fees of most money-market funds, he notes.

Kahan recommends preferred shares (yielding 6% to 8%) of bank companies, including Fleet Financial and HSBC, and of real estate investment trusts, including Vornado Realty and Health Care Properties. He likes junk-bond mutual funds, including Columbia High Yield and Northeast Investors. He also favors short-maturity bond funds (which yield just north of 1%) like Vanguard Short-Term Bond. Bank CDs are another alternative to money-market funds. Keep a mix of CDs that come due in three, six, 12 and 18 months. You can get 2% on a three-year CD, but you’ll run the risk of locking in a historically low yield just as yields–and total returns on dividend-paying stocks–start to rise.

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