Originally published on August 16, 2021 USNews.com
Dividend stocks have been a trusted friend for years. But in today's market, the relationship needs some new parameters.
The yield of the S&P 500 and the 10-year U.S. Treasury bond are at about 1.3%. That's near an all-time low. The S&P 500 hovered at a 2% yield for a long time, but dividend cuts and suspensions during the pandemic, as well as the strong bounce in stock prices over the past 15 months, have pushed it down to that paltry level.
After years of appreciation in the prices of stocks and bonds, an investor entering or nearing retirement is staring at an income abyss. And dividend investing is not the simple, go-to source of income that it used to be.
Here's what financial advisors should understand about the changing landscape of d
Low yields might be the biggest challenge for financial advisors since the 2008 global financial crisis. Throughout most of that disastrous time for investors, however, the stock and bond market indicators were yielding more than twice what they do now.
An investor who is shifting from accumulating wealth to living on that wealth has two related problems to confront: bubble levels in stocks and bonds, and the resulting level of yields, which doesn't come close to supplying the income needed in retirement.
This forces financial advisors to make some high-stakes choices. One option is to continue to push the growth pedal and hope that the past 12 years of stock and bond returns repeat themselves. But in this phase of the economic and market cycle, that is dangerous for the client and represents career risk for the advisor.
Think about all the work you put into adding great clients to your practice. Then, think about how you would keep their confidence if, in the first couple of years, their stock portfolio fell by 25% to 50%, or their bond portfolio fell by 15% to 25%. That is well within the realm of possibility when stock or bond bubbles pop.
Even investors who are used to stock market declines are not used to seeing a crash in their bond portfolio. Maybe it will never happen. But as many advisors now realize, investors are one Federal Reserve "taper tantrum" away from unleashing some changes that will quickly have you defending your usefulness.
Investment income is among the most popular objectives for high-net-worth and mass-affluent investors. But bond markets are so manipulated by central banks these days, it's a long shot to count on bonds to play a central role in retirement income.
You can experiment with the wide variety of newfangled income-driven alternative investments, but since many of them involve limited liquidity or complex product structures, they may ultimately suffer the fate of many similar innovations from the 2008 crisis.
Tighter liquidity typically causes speculative activity to drop sharply as margin and other forms of leverage go bust. So having your clients in more familiar investment vehicles is a distinct advantage.
But if bonds and alternatives don't help clients pursue a sustainable, comfortable, low-drama income portfolio, what does? How do you stand out in an era of near all-time lows in income yield and the increasing competitiveness in the financial advisory businesses? Good old dividend income may be the right route, albeit with some additional guardrails for the unprecedented times we live in.
Some advisors have fallen into using dividend-paying stocks, high-yield stocks or even value stocks to convince clients that there is a portion of their portfolio that will somehow deliver above-average dividend income while preserving more of their capital than the broad stock market does. But it's not as easy to pivot to these usual suspects as it was during past years.
Enter a more tactical approach to analyzing and managing a portfolio of dividend stocks. The basic concept is to avoid yield-chasing as well as return-chasing. Stocks with high yields make for nice headlines when you buy them. Today, it is more important then ever, however, to look instead for a combination of a high relative yield (versus what that stock typically yields) and a price that is down but not vulnerable to more waves of selling.
After all, what good is finding a 4% or 5% yielding investment if you stand a good chance of seeing five to 10 years of yield vanish in a crash? Evaluating the risk-reward trade-off before you buy or sell is the key to any investment decision.
In today's dividend investing world, a changing landscape means a few old habits need to change. Here's what advisors should know.
Don't force yourself to be fully invested in the dividend portfolio at all times. Some market environments simply do not reward you for the risk you take. Sometimes, you can fill a portfolio with 20 to 30 solid dividend stocks and buy them at yields that can potentially deliver a solid income stream to your clients with a low probability of a big, sustained drop in the portfolio's principal value.
But this is not one of those times. Risk is high, and that means accepting that you might have more cash waiting for good long-term buying situations than you normally do. There are many alternatives to cash these days while you wait for those stock values to develop.
When a stock is cheap, that does not mean it is a buy. Today's risk levels in the broad market make this crucial investing tip even more critical to remember.
With dividend stocks, for example, if you find a stock that yields 4% when it typically yields 2% to 3%, that implies that the price has likely come down recently. Sometimes, that is a great long-term situation to pursue. At other times, it is a red flag. This is why traditional habits of advisors, such as screening for stocks or exchange-traded funds with high yields, are no longer as foolproof as they once were.
Create your own universe of securities. Rather than try to identify stocks that appear cheap, it's better to establish a field of companies you are willing to own at the right price and yield level.
That requires some effort before a specific stock hits your radar. Developing a universe of potential investments is, frankly, one of the things your clients expect you to do, either individually or with outside help. It is your proof that no matter what the outcome of the investment portfolio is, you took prudent, disciplined steps to create and maintain a consistent investment process.
Stock market investing is far from a guarantee. All an advisor can do is plan for a variety of portfolio outcomes. Because high-quality, reliable, sustainable investment income is harder to identify than ever, the years ahead will require a new approach to dividend investing.