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By Christine Benz | 10-18-2012 02:00 PM

Dividend-Paying Stocks Are Not Bonds

Vanguard's chief economist, Joe Davis, cautions investors who turn to equities to replace bond income and also offers some vehicles for short- and long-term inflation protection.

Christine Benz: Hi, I'm Christine Benz for Morningstar. With yields as low as they are, many investors are concerned about what lies ahead for bonds. Joe Davis, Vanguard's chief economist, recently sat down with me to share his perspective.

Joe, thank you so much for being here.

Joe Davis: Thank you, Christine.

Benz: One topic I'd like to touch on with you is fixed income. This has been a very vexing part of many investors' portfolios. I think there are a lot of concerns that interest rates could rise. What's your counsel to investors attempting to navigate their fixed-income positions today?

Davis: Great question, Christine. Twofold, the first is that we're really trying to recalibrate return expectations going forward for bond investors. As you mentioned, the past 20-30 years have been actually fantastic return performance in aggregate for fixed income. However, given the initial yield to maturity on many bond portfolios, it is highly, highly unlikely that the returns on, say, the next five or 10 years will mirror those of the past 10 or 15. So, we have to recalibrate return expectations. At the same time, we're also underscoring the strategic role that bonds can play in a portfolio, the diversifying property in a broadly balanced portfolio that, say, might help diversify equitylike volatility. So, again, long-term message, portfolio construction is similar; it's very much the same as we've always have. At the same time the returns that we would expect bonds to provide us are going to be lower in a nominal sense for the foreseeable future.

Benz: Are you concerned that investors in this quest for yield, and it is a very low-yield environment, are perhaps taking on outsized risks with their fixed-income portfolios these days?

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