Looking For Yield In All The Wrong Places

Dividend investing is one of the tastiest flavors of the month for do-it-yourself planners, but advisors may have good reason to be wary of the dividend growth and yield fads.

As yields offered by relatively low-risk assets like CDs and bonds declined over the past three decades, investors turned to riskier assets to fill their income needs. The inflation of the 1970s sapped the purchasing power of bond interest, leading investors in the 1980s and 1990s to harness high-quality dividend paying stocks.

“We’ve encountered investors who were first forced from their CD at their bank into the bond market, and now they’ve been forced from the bond market into equities,” says Mark Travis, CEO and president of Jacksonville, Fla.-based Intrepid Capital. “Investors look at a 2.2%-yielding 10-year Treasury bond and, without knowing better, believe that they could just buy GE with a 5% dividend yield without worrying about the risks.”

Income Investing

Retirement-minded investors are crafting income strategies focused on interest and yields.

Income investing believes that by focusing on a security’s yield and the likelihood that the yield will be paid over time, the price movement of an investment can be eliminated as a factor in investment decisions. This creates a psychological prompt for income investors to hold their positions over the long term.

“Income investors are not supposed to be concerned about a price—if an investor can handle a 50% to 80% drawdown, then running a dividend strategy is probably fine,” says Mebane Faber, CIO of Cambria Investments.

Many advisors argue that income investing neglects opportunity to create cash flows from other sources, like capital gains and principal. By using pricy pure income strategies, retirees risk sacrificing their lifestyles and their ability to leave a legacy.

Retirement is growing more expensive, and the cost of creating income from yield is becoming pricier over time. Historically low bond returns, projected low rates of return across multiple asset classes and low inflation mean that each successive wave of income investors will receive less annual income from their initial investment.