O'Shaughnessy: Want Income? Look at Stocks, Not Bonds

Conventional wisdom is that investors looking for income (as opposed to capital gains) should focus on bonds. But in his latest market commentary on his firm’s web site, James O’Shaughnessy says history shows there is a far better way.

O’Shaughnessy’s firm conducted a study that covered the period from Dec. 31, 1962 through the end of 2009, looking to see how much money income investors would have made had they invested in high-dividend stocks (via his “Enhanced Dividend” strategy), and how much they would have made by investing in 10-year Treasuries. The study used a $250,000 initial investment, and assumed that investors would each year use up all of the income generated by that investment.

The results: Over the 47-year period, dividend income from the stock portfolio declined in only five years; over the course of the full period, the dividend income grew from $11,102 in 1963 to $814,770 in 2009. The total amount of income the investor received (and consumed): $7.84 million. The bond portfolio, meanwhile, provided income of between $9,875 and $34,800, depending on the year. The total amount of income the investor received (and consumed): $888,250. And, of course, the dividend stock portfolio crushed the bond portfolio in terms of growing the principal of the initial investment.

Two big reasons for the huge discrepancy, O’Shaughnessy says, are inflation, and the fact that bonds don’t allow your principal to grow the way that stocks do.

“For me,” he says, “the problem with fixed income investments is that they are fixed. Once you lock in a yield — if you hold the bond to maturity — you will receive the same coupon payment for the remainder of the bond’s life. While that might work fine in a stable economic environment with low inflation, it becomes a big problem if inflation is consistently reducing the purchasing power of your annual earnings.” And, he adds, “with current government deficits and debt running amok expecting inflation rates to remain low is wishful thinking — indeed, given current trends, it is more likely that inflation will be significantly higher over the next ten to 20 years than it was from 1970 until now.”

O’Shaughnessy also looks at a variety of other variations — shorter time periods and taxable vs. non-taxable accounts, for example — and his data shows that the dividend strategy still handily beats the Treasury bond approach, both in terms of income and principal growth. To read his full analysis of the study, click here.

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