Boosting portfolio yield with income stocks

by Kristina Hooper, Chief Global Market Strategist, Invesco

Female financial advisor discusses dividends with clients.

Key Points

  • Today’s low-interest-rate environment is challenging for income-oriented investors.
  • Dividend-paying stocks offer competitive yields compared to bonds currently.
  • A variety of factors create a favorable environment for investors to choose dividend-paying stocks.

Investors seeking to generate income through traditional means have struggled in a persistently low-interest-rate environment. As a result, many income investors have been forced to cast a wider net beyond traditional fixed income securities, reaching lower on the quality spectrum to access any meaningful yield. Doing so, however, can shift the risk profile of a portfolio much higher than the investor ever intended or wanted.

The good news is that we are in an environment where stocks — dividend-paying equities, specifically — have become a more attractive solution for income investors.

Bonds: waning appeal to income investors

The stance of global central banks is primarily why bonds — typically the place for income investors — have lost their appeal recently. The Federal Reserve has clearly telegraphed that it is shifting gears and is now prepared to cut interest rates to help extend the now decade-long economic expansion.

Unfortunately, there are few viable alternatives to domestic bonds. The European Central Bank has signaled its desire to cut rates, and the Bank of Japan, which has been seeking more ways to stimulate growth, is also poised to follow suit.

This has resulted in a universe of negative-yielding sovereign bonds that has grown to approximately $13 trillion.1 This challenge is not limited to government debt — nearly a quarter of investment grade corporate credit has been negative-yielding as well.1 Even bonds that are generating a lower but still positive income component run the risk of not being able to keep up with inflation.

Dividends as an income source

Income investors today need to expand their horizons, and dividend-paying stocks are an attractive alternative to bonds. Research shows that over the longer term, a significant portion of the total return generated by stocks is attributed to dividend income and the reinvestment of that income.2

There’s even a tax benefit; dividends paid by qualified U.S. companies may offer a tax-advantaged form of yield compared to earnings from bonds. Under current law, qualified stock dividends that meet certain requirements are taxed comparably to the more favorable capital gains tax rate, which could result in a greater after-tax return for investors versus what they’d retain after-tax from bond income.

6 reasons to consider dividend-paying stocks

We believe there are six reasons why dividend-paying stocks may be an attractive income option for yield-starved investors in the current environment.

  1. A “dovish” turn by the Fed. We expect that the Fed’s shift to a more dovish stance, meaning a greater willingness to cut interest rates to stimulate the economy, will support equities, including dividend-paying stocks.
  2. A potentially more volatile investment environment. Markets are likely to experience more dramatic ups and downs in the coming months given rising geopolitical risks. Stocks that pay dividends and increase those payouts regularly have historically exhibited significantly lower volatility than non-dividend paying stocks.3
  3. Attractive comparable yields. As of the end of May, the yield on the benchmark S&P 500 Index was 2.12%,4 fairly comparable to the yield of the 10-year U.S. Treasury note. Dividend-paying stocks offer the advantage of capital appreciation potential combined with a stream of income. In addition, approximately half of the stocks in the S&P 500 Index paid a dividend yield that exceeded that of the 10-year Treasury note in recent months.

  4. Low expectations for investment returns. In the next decade, we expect to see more muted returns for many asset classes, including equities. In such an environment, dividend income becomes all the more important in terms of enhancing overall total return.
  5. Demographic trends. Baby Boomers should anticipate longer retirements due to rising life expectancies. Dividend-paying stocks could be a “sweet spot,” offering both income and capital appreciation potential.
  6. A broader universe of stocks to choose from. There was a time when investors turned mostly to utilities and basic materials companies as sources of dividend income. Today, dividend-paying stocks can be found across a broad range of industry sectors. Even some technology companies, which have historically avoided paying dividends, now offer attractive yields.

 

Where does your portfolio stand?

Probable interest rate cuts by central banks, geopolitical risks, modest return expectations and demographic trends all enhance the appeal of dividend-paying stocks. This is especially true for those trying to find ways to generate income from their investments. Talk to your financial advisor about how you can potentially capitalize on this opportunity in your own portfolio.