Canny investors can tap choppy markets

Those among you who truly, deeply, believe that dividends lie at the heart of wealth creation should be cheered up by movements in US Treasuries over the past couple of weeks.
Canny investors can tap choppy markets

These bonds had been driven to levels that generated ultra low coupons over the past year, with yields often hovering around 1% or 2%.

At those levels, a $10,000 investment in a gilt-edge instrument provides annual income of just $200. If you need an investment pot to deliver an annual income of $10,000 you would have to hold a whopping $500,000 in US bonds to hit your target.

US Treasuries, however, are starting to sell off as the investment community weighs in on the post-presidential election result.

Markets believe that a deficit-producing spending programme is now afoot in America and that will drive growth in inflation. Such conditions are not conducive to keeping bonds at low yields.

That shift in yields is being interpreted in some quarters as a preface to a much longer and deeper sell-off in fixed income instruments. You may ask why this matters for investors.

There are multiple consequences;

(1) bond funds worldwide hold trillions of dollars from investors and if these decide to move away from fixed income and into equities it could boost the latter;

(2) higher bond yields impact the performance of bond-like equities;

(3) bonds, themselves, become more attractive to investors as their prices fall because annual dividend coupons make the returns more attractive.

Imagine a bond price that offers a yield of 1% falling to a price offering 4%. Then, instead of needing $1m to produce a $10,000 annual coupon an investor needs $250,000 to deliver the same return.

I’ve argued in the past that shrewd investors must constantly be on the prowl for equities that provide reliable annual cash dividends that can re-risk the challenges posed by volatile markets.

A portfolio of shares that provides solid dividend yields can help shape a quantum of wealth. Alongside that mix of dividend-producing equities it is advisable to develop a fixed-income pot that provides recurring income.

Recently, the challenge has been to find equities and bonds that can achieve these objectives without costing a fortune.

Those earlier in life and career should recycle dividends from a starter fund back into a similar portfolio of shares and bonds. Those closer to pulling the trigger on work have to think differently.

For them, the challenge is to facilitate an annual cash payment which can be used for living expenses while protecting the core capital so that future dividends are reliable.

If you had asked me a year ago should we expect a change in bond markets that would unzip better income-generating opportunities I would have said no. With QE and low central bank interest rates the dividend returns from all assets was flattened. That may now, courtesy in part to the US election result, be changing.

Joe Gill is director of corporate broking with Goodbody Stockbrokers. His views are personal.

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Wednesday, September 15, 2021

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