By Chloe Lutts
Editor of Dick Davis Investment Digest
and Dick Davis Dividend Digest
How to Recognize Bond Market Extremes
It's Time for a New Paradigm
Stocks to Start an Income Portfolio
Traditionally, investors thinking about retirement have invested
in a mix of stocks and bonds designed to balance safety and growth.
The closer to retirement or more risk-averse they are, the more of
their portfolio they hold in bonds for safety and regular income.
The system has even been institutionalized in the form of
"target-date funds" that automatically put more of your holdings in
bonds as you near retirement.
But today, more and more investors are questioning this model.
Specifically, the interest rates of the last few years have forced
many investors to rethink the bond portion of their portfolio.
Bonds just don't fulfill the needs of retired investors any
more: Interest rates are so low they don't provide enough income to
live off of, and most bonds will actually lose value over the next
few years. Ten-year bonds issued recently have yields under 2%.
Treasury Inflation-Protected Securities (
) are actually being issued today at negative yields. (At the
January 31 Treasury auction, 10-year TIPS were issued with an
interest rate of -0.63%.)
Not only are those interest payments too insignificant to fund
your retirement, but once interest rates begin to increase (which
they will, eventually) those low-yielding bonds will fall in value.
Bonds that are being issued at just slightly below face value today
will most likely be worth significantly less than face value in a
Buying newly-issued bonds today would be foolish.
But it's hard to throw an entire investment paradigm out the
window. The fact is, though, it's not the first time bond investors
have had to adapt to a new paradigm. Thirty-two years ago, in 1981,
30-year Treasury bonds were being issued with yields of 15%. And
previously-issued 30-year bonds were selling for huge discounts: a
30-year bond issued in 1970 that yielded 7.875% could be bought for
56% of face value in 1981.
Yet, investors thought bonds were a terrible investment. A bond
trader quoted in the New York Times that year said, "Anyone who
buys a bond today to hold for more than five years is out of his
The reason was high inflation and a 35-year bear market in bonds
that had lasted from 1946 to 1981. At the time, investors thought
inflation would remain in the double digits for the foreseeable
future. The bond trader above and others quoted in the same New
York Times article also expected inflation to continue to rise,
making even the newly-issued 15%-interest-rate Treasury bonds a bad
In retrospect, that seems like an insane assumption. But, as New
York Times financial columnist Floyd Norris wrote a little over a
month ago, "A lot of people on Wall Street in 1981 could not
remember a time when bonds were good investments."
Of course, over the next 30 years, the bond market enjoyed a
wonderful rally, and we now find ourselves in the opposite
situation: everybody buys bonds, and yields are at rock bottom.
And unsurprisingly, Wall Streeters are now acting as if they
can't remember a time when bonds were bad investments. Or, as a
Barclays banker quoted in Norris' column said, "They say that fish
don't know that they live in water-until they are removed from
it-and we wonder if some of the many market participants whose
entire professional experience has been conditioned by the
financial backdrop created by the bond market rally might
underestimate some consequences of its termination."
Luckily, you aren't a fish. And hopefully, as a reader of
Cabot Wealth Advisory
, you've had the courage to take control of your investments, and
thus have the power to abandon this outdated paradigm now, before
the aquarium-dwelling bankers come to the same realization.
Of course, abandoning low-yielding bonds is probably going to
leave a pretty big hole in your retirement account. And you're
going to want to fill it with something safe and income
One solution, which many retired or retiring investors have
already embraced, is to craft a personalized combination of
dividend-paying stocks. The hundreds of dividend-paying stocks
traded on major exchanges makes it easy it tailor a portfolio to
your risk tolerance and income needs. Just take a foundation of 2%-
and 3%-yielding blue chips and dividend aristocrats, add some
undervalued stocks with historically high yields or
dividend-growers to boost your yield in the future, and then top
off with a sprinkling of riskier but higher-yielding
For the best ongoing advice on creating a portfolio of
dividend-paying stocks, I have to recommend my own newsletter, the
Dick Davis Dividend Digest. If you take a trial subscription today,
we'll even start you off with a special report with 10 great
candidates with a range of yields perfect for starting a layered
income portfolio like I described above. Then every month, you'll
get 30 new ideas in the Dividend Digest. I highly recommend you try
Of course, I can still give you a few ideas here.
For the foundation of your safe income portfolio, you might
consider replacing bonds with large-cap blue chip stocks that have
low volatility and have paid dividends for many years. Something
Kellogg Company (
Kellogg was chosen as a Top Pick for 2013 in our latest Dividend
Digest issue by Jim Stack, editor of InvesTech Market Analyst. He
"Kellogg Company (
), our top conservative idea for 2013, is the world's leading
producer of cereal and, with the May 31 acquisition of Pringles
($1.5 billion in sales), it became the world's second-largest
player in savory snacks. Founded in 1906, the company has become a
global giant that maintains manufacturing facilities in 18
countries and sells its products in 180 countries.
"Although Kellogg is already arguably the best-known brand in
breakfast products, the firm continues to focus on innovation and
brand building, where it spends more, as a percentage of sales,
than any other company in its peer group. Consequently, new
products last year accounted for over $800 million in sales.
"Strategic acquisitions also provide an avenue to future growth.
The recent Pringles addition tripled Kellogg's international snacks
operations and management recently stated that so far Pringles has
exceeded expectations. The deal also opens avenues for the company
to further expand its global platform.
"Despite this $2.7 billion acquisition, Kellogg's finances
remain on firm footing. The firm's return-on-equity, which measures
its profit generating efficiency, is greater than 50%, more than
double the industry median of 23%. Expectations are that earnings
will grow at a healthy 7% to 9% annual rate for the next
"Also, this stock should be particularly attractive to
conservative income-oriented investors as it offers an attractive
3.1% dividend yield, a dividend that has grown at an average rate
of 7% annually over the last eight years. Moreover, as a member of
the Consumer Staples sector, the stock is typically more resilient
in the event of a market downturn.
"From a valuation standpoint, companies like this are rarely a
bargain. However, Kellogg is currently selling at a Price-to-Sales
ratio of 1.5, which is below its 10-year median of 1.7. This
discount, together with the stimulus provided by the Pringles
addition, should make Kellogg an attractive addition to any
This year's Top Picks issue also had some great ideas for the
high-yield tier of your bond-replacement portfolio. For example,
Ian Wyatt of High Yield Wealth chose as his Top Pick for 2013 a
real estate investment trust, or REIT, that currently yields nearly
8% (plus, it pays dividends monthly). Here's part of his
"Income investors are plagued by low interest rates and a dearth
of reliable income sources. For this, we can thank the Federal
Reserve, which has wrung interest payments out of the fixed-income
market. Fortunately, there is an investment that provides
high-yield safe income: Gladstone Commercial Corporation (
), a diversified commercial real estate investment trust.
"Gladstone Commercial owns 77 properties covering 21 states from
Rhode Island to Texas. Gladstone's portfolio is composed of
commercial, industrial and retail properties. Moreover, 98.8% of
its portfolio's total square footage is occupied, and all tenants
are current on their payments.
"As a REIT, Gladstone doesn't pay income tax at the corporate
level. This means more cash is distributed to investors. In fact,
Gladstone's $1.50-per-share annual distribution yields 8.5%-roughly
four times the yield of the S&P 500. Gladstone's average
price-to-FFO (funds from operations) multiple of 11.5 is less than
the industry average, but this is likely due to Gladstone's small
size and lack of institutional following. If the market yield were
applied to Gladstone's 2011 FFO of $1.53, you'd be looking at a
$23.50 share price-a 30% increase to the current market price. In
short, Gladstone is a value-priced, risk-averse REIT that is a
model of high-yield dependable income."
What do you think? Have you replaced bonds with dividend-paying
stocks yet, or are you thinking about it? If you did, would your
portfolio be full of more high-yielders like GOOD, or blue chips
like K? Let me know by replying to this email.
Wishing you success in your investing and beyond,
Dick Davis Digests
Best Dividend Picks of 2012
Two Dividend Aristocrats for 2013