Investment income: Don’t be short-sighted…
- by Glenn Wessel, CFA, CPA, CFP®
When choosing among investment alternatives where income is a primary consideration, conventional choices often include money market instruments, CDs, bonds, bond funds, unit investment trusts, and certain types of annuities. Notably absent from that list is the lowly dividend-paying, common stock. Because common stocks can be volatile, they are often excluded as a viable income solution. That could be a mistake.
While it is true that at any given point in time the income (yield) of the typical dividend-paying common stock is likely to be significantly less than the yields that are available on competing income instruments, the story does not end there. Consider for a moment an investor who has a need not only for current income, but a need for that income to increase over time. Why might an investor need a rising income stream? Well, if the cost of living were to increase by 3% per year over a 20-year period, the purchasing power of a dollar would fall by about half. So, in 20 years that investor would need about two dollars of income for each dollar of income received today – just to break even!
Assume you had $1,000 to invest back in 1996 and you were trying to choose between a money market account*, or General Electric common stock. In 1996, the yield on that money market account may have been around 5% – more than twice the yield of GE’s common stock. Which would you have chosen?
If you were tempted to choose solely on the basis of the higher current level of income, you would have chosen the money market account. But unless you were convinced GE could not grow anymore, that decision would have been short-sighted. Take a look at the income that would have been produced by these two vehicles on that initial $1,000 investment:
Over this 10-year period, the dividends received on that GE stock would initially have been substantially less than the income received from the money market account, but by owning that GE stock, you would have received an income raise each year en route to ultimately receiving 65% more income. And, since owning GE stock has allowed investors to participate in GE’s increasing fortunes, the value of that GE stock would also have more than tripled in value over that same time frame. For simplicity sake, let’s assume that GE stock only tripled in value over this time frame. Here’s how the numbers shake out:
|Initial Value of Investment||$1,000||$1,000|
|Ending Value of Investment||$1,000||$3,000|
|Beginning Income Yield on Initial Investment||5.10%||3.20%|
|Ending Income Yield on Initial Investment||3.40%||9.20%|
This is not a commercial for GE stock because similar outcomes would have been possible for many other stocks. But, the lesson is clear: When considering income alternatives, a most important consideration is how that income might increase over time.
*Money market results approximated by Fed data on 6-month Treasury securities.
Glenn Wessel has an investment counsel and financial planning practice in downtown Asheville. He has been admitted to the Paladin Registry as an elite financial advisor.