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By Christine Benz | 10-13-2011 09:44 AM

Ferri: Dividends May Lure Investors Back to Stocks

Given current yields on stocks versus bonds, it may be an intelligent move for investors to allocate assets to dividend-payers, says Portfolio Solutions' Rick Ferri.

Benz: You recently wrote a piece, Rick, where you looked at dividend yields actually being higher than Treasury bonds. What do you think investors should make of that? I have heard from some investors, where they are saying I want to take a piece of my bond portfolio and put it into dividend-paying stocks. Does that make sense to you as a strategy?

Ferri: Interesting what happened here. It has been 50 years since the yield on stocks has been higher than the yield on 10-year Treasury bonds, 50 years. You have to go all the way back to the early 1960s to see that.

And prior to that, interestingly enough, there used to be a rule that said, when the yield on stocks is higher than the yield on Treasuries, you buy stocks and you sell bonds, and when the yield on stocks falls below bonds, you sell stocks and you buy bonds. That was sort of the market-timing mechanism that people used from the 1880s all the way through to the 1960s, until it didn't work anymore, because the way corporations started to structure their balance sheets and use more equity and not pay dividends, buy back stock, and they changed the whole corporate structure.

Is it going to change people's belief of the stock market? I think that, you might get some people who say, stocks are yielding higher than bonds right now, and if I put money in stocks and don't sell it, I'm going to get certain amount of cash flow from that now, but stocks also have paid higher and higher and higher dividends. So, as companies make more money, they increase the dividends, and this dividend increase maybe runs about 3% per year, which happens to be about the inflation rate. So, if you're making $10,000 from dividends now, next year you might make $10,300, the year from that $10,600, the year after that $11,000. So, there is this automatic inflation-adjusted increase.

Now, there are times when the markets really take a dive, like in 2008, where the dividends were cut, but they are coming back pretty strongly right now. So, there might be some investors who come back to the stock market only for the cash flow, and I think that would be interesting, not only that, but maybe an intelligent thing for some people do.

Benz: But they are getting a lot more volatility by swapping out of fixed-income?

Ferri: They are getting volatility in their principal, but if they are buying stocks for the cash flow, and they are never going to sell, then the volatility of the stock market shouldn't affect you, because what you are really buying is the income stream from it.

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