Due to ZIRP the interest available on deposits has dwindled to almost nothing. CD’s for 1 year are around 1% or so and for 5 years they are at 1.7%. After tax, this yield is minuscule, especially since interest is currently taxed as ordinary income at up to 35% or so depending on your state. While tax policy is in flux, it is safe to say that you won’t get much more than around 1% after tax on your money in the savings market without taking some risk.
On the other hand, dividends are rising for many corporations. If you go to any sort of stock screener and look world wide there are a large number of stocks with dividends in the 3% – 5% yield range that appear to be solid and well capitalized companies. In addition, under current tax policy, dividends are taxed more favorably than interest on CD’s or bonds.
Bond ETF vs Dividend Stocks – the Experiment
Thus as an experiment I decided to pit two tracks against each other.
1. Buy a reasonable proxy for the bond market and track interest received and changes in principal for return (Vanguard BND ETF)
2. Select a group of dividend paying stocks and see how they perform in terms of dividends received and capital appreciation (or declines)
I originally looked for a dividend ETF but I didn’t see one that I liked because I wanted companies from around the world, not just the US, and I didn’t want a lot of financial institutions. The ETF’s that I saw had expenses in the 0.2% up to 0.5% and I have a lot of free trades in my account meaning that my expenses for my own selections effectively cost 0% in terms of expenses. Finally, I thought I could do some “tax harvesting” and offset gains and losses and perhaps end up with a “net loss” position that I could deduct towards my net $3000 limit each year (whether or not the portfolio actually was running a loss, if I sold individual stocks that were at a loss I could either offset gains elsewhere or just take the losses against total income up to $3000 / year). This is why I picked individual stocks in this test rather than an ETF.
The Results After Five Months
My results were that the bond baseline (BND) returned about 1.4% annualized for the 5 month trial including dividends and changes in share price. The stock portfolio returned about 18% in the 5 month trial including dividends and changes in share prices. You can see the portfolio results in the links on the left or here.
As I started to invest in the dividend portfolio I realized that the stocks were highly volatile. Since I was investing ostensibly for yield (to receive dividends), I was inclined to ride out the volatility and try to do a “buy and hold” plan but as stocks gyrated I instituted my own rule that I would (generally) sell when a stock rose 15% or when it fell 10%. This rule would protect my portfolio from extreme gyrations. After all, if you are looking to eke out 3% – 5% / year you don’t want to take a 15% net loss to earn that or the whole exercise is counter-productive.
I started with 12 stocks in early July, 2012 and by the end of November (about 5 months later), EIGHT of those stocks had been sold due to the rules above. Thus roughly 2/3 of my portfolio turned over in 5 months, meaning that you’d have an annual churn rate of 160% if my picks were indicative of the overall market.
The dividend stocks seemed to be very sensitive to any sort of thought that the dividend rate might be cut, and were subject to large losses immediately if the dividend actually did get cut. A couple of the clunkers in my portfolio, AVP (Avon) and EXC (Exelon) both had dividend coverage problems and big dives as a result (relative to my goals, 10% is a big dive).
On the other hand, the overall rise in my portfolio was likely due mostly to a rise in world wide stock indices during the time frame of this effort, July – November 2012, which saw indices increase between 4% – 6% depending on which benchmark you use (which annualized out gives most of the return I received, above).
Buying dividend stocks to get yield as an alternative to CD’s or similar instruments is not a good apples-to-apples choice. The return is so heavily skewed by equity market gains and losses that the dividend return is a small component of your total return.
This doesn’t mean that based on my experience that dividend based stocks aren’t a good idea – they are dependent on many variables including equity markets, your tax situation, the sectors you select, tax withholding for foreign companies, etc… but their volatility will make it a wild ride.