Dividend Paying Stocks Are NOT a Safe Substitute for Bonds – Here’s Why

Dividend Paying Stocks are Not a Safe Substitute for Bonds! Ever! DIVIDEND PAYING STOCKS ARE NOT A SAFE SUBSTITUTE FOR BONDS!  EVER!  EVER! Did I write that big enough?  Maybe not.  Let’s try again: DIVIDEND PAYING STOCKS ARE NOT A SAFE SUBSTITUTE FOR BONDS!  EVER!  EVER! Here’s why.

The above introductory comments are edited excerpts from an article* by Cullen Roche (pragcap.com) entitled Dividend Paying Stocks are Not a Safe Substitute for Bonds … Ever!.

The following article is presented by Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!),  www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and the FREE Market Intelligence Report newsletter (register here; sample here).  This paragraph must be included in any article re-posting to avoid copyright infringement.

Roche goes on to say in further edited excerpts:

Okay, you get my point.  Of course, saying it isn’t enough.  There should be some empirical data to back up this assertion.  First, a bear market in bonds is nothing like a bear market in stocks.  When someone compares the two instruments it means there is a high likelihood that they don’t understand the capital structure very well and haven’t connected all the dots here.

The Difference Between Bonds & Stocks

A fixed income instrument has several embedded safety components that make it entirely different from stocks:

1. It’s higher in the liquidation chain.
2. It pays a “fixed income” over the course of its life.
3. If held to maturity fixed income pays you back at par.
4. The duration on a fixed income instrument is generally shorter than that of common stock.

This explains why fixed income is inherently safer than common stock.  We can see this in the performance data.

• Since 1928 the 10 year US Treasury note has been negative in just 14 calendar years.
• Those negative years averaged a -4.2% return.
• Stocks, on the other hand, have been negative in 24 of those calendar years and
• with an average decline of -13.6%.
• The worst calendar year decline in stocks was -43% while
• the worst calendar year decline in bonds was -11%.

…[The above makes it very] clear that a bear market in bonds is very different from a bear market in stocks.

The Difference Between Bonds & Dividend Paying Stocks

…People often confuse dividends for making an equity instrument similar in some way to a fixed income instrument.  This is completely wrong.  An equity instrument that pays a dividend still lacks all of the aforementioned built-in safety components that differentiate fixed income from common stock.  It just means the company pays a dividend stream (which isn’t actually fixed and can be revoked at any point as many people found out during the financial crisis) and, more importantly, dividend paying stocks can be atrocious performers at times and it’s often because high dividend paying stocks are leveraged companies who borrow funds to finance dividends and operations.  This was most obvious during the financial crisis.  Take for instance, the iShares Dividend fund which cratered -62% during the financial crisis.

Conclusion

DIVIDEND PAYING STOCKS ARE NOT A SAFE SUBSTITUTE FOR BONDS!  EVER! EVER!

Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.

*http://pragcap.com/ (Copyright © 2014 All Rights Reserved)

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