I had the pleasure of sitting buy a pool with our favorite financial whiz Ray Link a couple weeks ago. Fueled by copious cocktails we spent the afternoon lamenting the see-saw stock market. We both identified our current favorite catagory of stocks – the blue chip big dividend payer. Ray was in the process of developing what I think is a terrific and relatively safe alternative to a cash portfolio that I am pleased to include below.
The Case For Stocks
by Ray Link
If you’ve been primarily in stocks the last decade, on average you’ve lost 20% of your investment, so not surprisingly many have thrown in the towel on equities and put it all in highly liquid, safe bank accounts and money market funds. The problem is that money markets are paying near zero. While I like cash, liquidity and safety as much as anyone, it makes almost no sense to stash the bulk of your financial assets in such low yielding investments.
Here is an alternative strategy that gives you reasonable returns with limited downside. I call it the “80/20 dividend yield program.” Let’s assume you have $100,000 and it is currently in a money market earning .25% (it is probably earning less) and that rate increases .5% per year so that after 5 years the fund is earning 2.25%. Over that 5 year period you would earn $6,395. An alternative for a conservative investor is a 5-year certificate of deposit which can still be bought with a 3% yield (Ally Bank, State Farm Bank and others offer this rate) and that would give you a total return of $15,927, over twice as much!
For even better yields, take 80% of the $100,000 and invest in a 5-year certificate of deposit at 3% and place the other 20% in high quality, dividend yielding stocks. The stocks I like are large, well capitalized, U.S. companies with international footprints that have a long history of paying and increasing dividends over time. Some examples are Campbell Soup, Chevron, Coca Cola, Heinz, Johnson & Johnson, Kraft, Intel, and Merck. All have a dividend yield of at least 3%. Investing just $20,000 in stocks such as these and $80,000 in a 3% CD gives you the same return before gains/losses on the stocks as investing in just the CD and markedly better than a money market. In addition the dividend income is currently taxed at a low 15% maximum rate versus 35% maximum rate on interest. Now comes the really good news. For you to have the same return as the money market fund the stocks would have to lose 47% over the 5 years. Put another way, unless you think stocks will lose at least 47% or if you think short-term rates will rise very rapidly, you should strongly consider some dividend stocks in your portfolio. On the plus side, if those same stocks go up 20% over the 5 years, which is very plausible, your total return is over $19,700 and the dividends are taxed at a lower rate and the gain would be long-term capital rates which are much lower than the rates on interest.
Consult your investment and tax advisors and ask them if the 80/20 program is a good fit for you.
Ray Link is a CPA and holds an MBA from the Wharton School. He is EVP/CFO of FEI Company (NASDAQ: FEIC), a world leader in tools for nanotechnology. He is also on the Board of Directors and Audit Committee for Cascade Microtech (NASDAQ: CSCD).