The Dividend Mandate
Income investors can’t help but be discouraged by the current state of affairs. T-bills yield 0.10%, and two-year Treasury notes yield 0.62%.
Albert Einstein described compound interest as the greatest mathematical discovery of all time, but compounding is not so great when interest rates are at 0.1%. At 0.1%, it would take 720 years to double your money!
For income seekers and those in or nearing retirement, there is no source of risk-free interest.
To earn a decent yield in the fixed-income market today, you must be savvy and selective. You have to pick your credit exposure and an optimal yield curve strategy. This isn’t an easy task. Self-directed investors are at a disadvantage here. Few have the time or inclination to manage a mutual fund portfolio, let alone a fixed-income portfolio.
Some investors will inevitably attempt to pick up yield by investing in long bonds. Many already have. Whatever you do, don’t join them. The folk who took a shortcut to higher yields by investing in long bonds just got a wake-up call. Long-term interest rates are up a full percentage point from their August lows. Long-bonds prices have cratered. The PIMCO 25+ Year Zero Coupon US Treasury Index ETF is down more than 26% from its August high.
If you want help navigating the current fixed-income environment, I’ll point you to Young Research’s Global Investment Strategy (GIS). GIS covers the global equity and fixed-income markets, as well as currencies and commodities. If you prefer an advisor, please consider my family-run investment company. We craft fixed-income and balanced portfolios with a focus on income.
On the equity side of portfolios, it is just as challenging to pick up income as it is in fixed-income markets. The S&P 500 dividend yield is only 1.89%. At a 1.89% return, you would double your money in 38 years. That’s better than the 720 years it would take in T-bills, but not at all satisfactory.
The pitiful dividend yield in the U.S. is caused by both an overvalued stock market and a low payout ratio. Far too many U.S. companies retain their earnings instead of distributing them to shareholders. And many of the companies that do distribute earnings to shareholders favor buybacks over dividends.
Dividends are superior to buybacks. Dividends are consistent and reliable. Companies only cut dividends when there is no other option. Stock buybacks, while a better use of cash than acquisitions, by example, are opaque and variable. It is most often the case that companies with buyback programs repurchase shares when stock prices are high and suspend buybacks when prices are low. The intention is to conserve cash during tough times, but it is in tough times that stock prices are at their cheapest levels.
U.S. companies could learn something from Brazil. In Brazil, dividends are mandated. Brazilian companies are required to distribute at least 25% of their earnings to shareholders. It is doubtful that the Brazilian dividend mandate is intended to be a shareholder-friendly regulation. This is Brazil we are talking about. The country isn’t exactly known as a bastion of free-market capitalism. The mandate is most likely in place to ensure that the government can collect more tax revenue from shareholders.
Whatever the motivation, the dividend mandate has appeal to income investors. As long as a Brazilian company is profitable, you can count on a dividend. Wouldn’t it be nice if all profitable U.S. companies paid a dividend? It would certainly make for a more attractive income-investing environment.