The composite rate for Series I Treasury Bonds for the first six months after May 1, 2024 is 4.28%. This rate is made up of a 1.30% fixed rate and a 1.48% inflation rate. But for income-oriented investors who can afford to stay in the market for at least a few years, I think stocks with growing dividends still make the most sense, counsels Scott Chan, editor at Investing Daily.
The potential upside from the bond comes from it being benchmarked to the inflation rate. The higher inflation goes, the higher the interest rate on that bond. But if inflation is flying high, the rest of your money is losing buying power. There are also limits on bond purchases and penalties that apply to select withdrawals.
Thus, a Treasury bond isn’t for everyone. This is why investors also look for other ways to maximize their income – like dividend stocks.
High yields, while they look attractive on the surface, aren’t as important as dividend growth and total return. Let’s say you buy 500 shares of a $20 stock with an 8% yield. This means you can expect to receive $1.60 per share in dividends in the next four quarters (assuming no change to the dividend over that time).
That comes out to $800 in annual dividend payments for the $10,000 total investment. But if the stock price falls 30% over three years to $14, your overall return, including the $2,400 in dividend received, would be -$600, or -6%.
Note that when a company pays a dividend, the stock price will adjust downward by that amount. So, over the three years, $4.80 per share of the stock price decline is attributable to the dividend payout. Adjusted for the dividend payment, the stock fell $1.20 per share over the three years — i.e., 6%.
Another way to look at a stock yield is how much dividend payment investors demand in order to take on the risk of owning that stock. Holding the dividend constant, the more demand for a stock and the higher the stock price goes, the lower the yield goes. Thus, a falling yield, if the dividend stays the same or goes up, is not a bad thing.
Conversely, a high yield means investors demand a generous dividend payment before they are willing to buy the stock generally due to perceived high risks and/or lack of capital appreciation opportunity. Note that in the case of the hypothetical stock, after three years its yield would rise to 11.4% ($1.60 dividend divided by $14 stock price). But since you are actually losing money overall, that’s not so good.
Therefore, it’s prudent to analyze a high-yield stock carefully before taking the plunge. Moreover, if the dividend isn’t going up in real terms (adjusted for inflation), that same dividend is losing value over time.
On the other hand, if you own a stock with a growing dividend, even if the yield is not that high (say, 3%) at the time you buy, at least the dividend will grow over time and help to mitigate the erosive impact of inflation.
