Dividend stocks for income investors
See Jim's new portfolio to help navigate the treacherous interest-rate environment.
Jubak's Journal
Recent articles:
• Why interest rates will march higher, 4/21/2006
• 5 stocks ready for inflation's return, 4/19/2006
• Why metals stocks haven't peaked, 4/18/2006
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Energy still the key for income investors
If youre an income investor looking to protect yourself against rising rates, energy funds and trusts offer the most security. I'm adding Penn West Energy Trust to my income portfolio.
By Jim Jubak
The Federal Reserve has signaled that it could be done raising short-term interest rates in May or June. But for all the reasons I laid out in my April 21 column, "Why interest rates will march higher," I think long-term rates will rise toward the end of 2006, climbing to 6% from today's 5% yield on the 10-year U.S. Treasury note.
Know what that means? A tough year for fixed-income investors is getting even tougher. My projected one-percentage-point rise in interest rates between now and December 2006 will result in losses for bond investors that are modest but still bigger than any they've suffered over the last 12 months. And the end of the Feds rate hikes at the short end of the interest-rate curve will make staying short, the safe alternative at the end of 2005, relatively less attractive as long-term rates creep higher.
So it's time to see if I can make the fixed-income portfolio that I launched last year work just a little bit better for you in the year ahead.
Beating the Lehman Brothers Aggregate index
Not that the portfolio as it exists has done badly. After putting $100,000 to work with buys on Oct. 14 and Dec. 6, the portfolio's value stood at $104,015 on Apr. 21. That's a total return of 4.02% in six months -- with the entire $100,000 not fully invested until just four months ago. Annualized, that comes out to a return of 8.19% in the course of a year.
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(In my calculations, I've deducted what I believe are transaction fees equal to those charged by the average online discount broker such as a Fidelity Investments. I have not reinvested dividends, and I have not subtracted any taxes. I've assumed an equal investment of $10,000 in each position. For the two certificates of deposit (CD) in the portfolio, I've assumed a yield equal to the median yield of the 10 top-yielding CDs as quoted on the MSN Money site on Dec. 6.)
That 8.19% annualized return looks even better when you compare it to a fixed-income index like the Lehman Brothers U.S. Aggregate Bond Index ($BNDUS). Year-to-date, thanks to rising interest rates, the total return on that index of all types of bonds, is a negative 1%. In other words, the decline in the value of your bonds exceeded the interest you received from your bonds by enough to reduce the value of your portfolio by 1% -- even after those interest payments. Remember that the price of an existing bond falls as interest rates rise.
The results over the 12-month period are only mildly positive, with the index showing a 0.6% total return.
Hunting for high dividends that can move higher
I think this validates the strategy that I set out to apply last year. At a time when interest rates were climbing and bond prices were likely to fall, I went looking for common stocks, master-limited partnerships and preferred stocks which offered both higher dividends and the prospects of higher dividend payouts in the future.
In such an environment, stocks have an important edge over bonds. Most bond yields -- except for those on floating-rate bonds -- are fixed at the time of issue. If interest rates go up, the only way the yields on already issued bonds can keep pace is if the price of the bond falls on the secondary market.
Companies with good and improving business prospects can -- and often do -- raise the dividends that they pay on a stock. Climbing dividend payouts can keep pace with a general rise in interest rates and, in the best of cases, even exceed the climb in rates.
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