Press Your Luck With Dividend Stocks or Fixed Income

One of my favorite gameshows from the 80′s was “Press Your Luck”. The popular phrase from that show was “big bucks and no whammies”! Unfortunately, investors looking for yield in 2012 and 2013 are only going to get whammies. It’s a very difficult time to invest looking for yield, and I actually call it a double whammy. We are going to get hit on two fronts, both will affect your investment returns.

Fixed Income

On one side you have fixed income investors who are getting no yield because the federal funds rate is set at 0 – 0.25%. The Federal Reserve recently announced this rate will be kept until 2014. The FED started this rate in 2008. So anyone who had a CD ladder for five years more than likely owned 5 year CDs. All of the previously high interest (remember the days of 4-5%+ APR CDs) will be renewed with low rate CDs. This will wipe out savers in this once decent return investment.

A ten year US treasury is currently earning less than 2% and is less than the current rate of inflation. Five year bank CDs are earning less than 2%. Prudent savers and retirees are getting pounded. So they have nowhere to invest to earn a decent return. You are losing money in real dollars if you invest in these options, because the actual inflation rate is much higher. Savers are forced to invest into risker assets because of FED policy. This is a problem not only because they are riskier investments, but also because of drastic tax increases in 2013.

Dividend Stocks

Forget for the moment that dividend stocks are not bonds, because that’s a whole other discussion. This fact hasn’t stopped investors looking for yield in this asset class.

On the other side, we have the Obama administration planning to increase tax rates for dividends in the 2013 budget. This isn’t including the Bush tax cuts that are set to expire by 2013. That is an automatic increase, unless Congress intervenes. Since it’s an election year, our political leaders will not have the courage to vote on anything before 2013.

It appears we’ll get a maximum 200 percentage point tax increase with dividends from the end of the Bush tax cuts alone. This isn’t including the Obamacare 3.8% increase with families whose overall income is above $250,000 (individuals with income over $200,000). All of this won’t bode well with investors and businesses who payout a dividend.

If you don’t think an increase in taxes won’t effect dividend stocks you’ll be sorely mistaken. History has shown tax increases/decreases affect the S&P 500 dividend payout. It’s predicted we will achieve a record high in dividend payouts this year. I suspect many companies will not increase or drop their dividends after 2012 and will instead favor stock buybacks. Unlike dividends, stock buybacks do not incur taxes for shareholders. By reducing the amount of available shares, the stock price naturally increases. However, stock buybacks aren’t the same as dividends.

This, of course, doesn’t do any good for a retiree who’s looking for spendable income. The exception to this rule will more than likely be the dividend aristocrats which have increased dividends for 25 years or more. I suspect even after a tax increase, this group of companies will keep increasing their dividends. This is unlike companies like Microsoft (MSFT), Cisco (CSCO) and Intel (INTC) who’ve recently introduced dividends.
“I am more concerned about the return OF my money than the return ON my money.” – Mark Twain

Obviously Mark Twain never lived in this economic environment. We aren’t getting a return on my money, nor are we getting a return of my money, as least in terms of real dollars.

Nowhere to Hide?

So what other options are available to earn a safe return above the rate of inflation, while having gains that offset the tax increases? Unfortunately, the options are slim, and in many cases are currently fully valued. The options are:

  • MLPs – In taxable accounts
  • REITs – Placed of course in tax differed accounts
  • Corporate Bonds
  • Muni Bonds
  • TIPs and I – Bonds
  • Peer-to-peer lending – For example Lending Club, which unfortunately is taxed as ordinary income but offers a higher rate of return.
  • Debt prepayment – I consider this the last resort, but at this point might be an investor’s best return

I certainly don’t consider treasuries, bank CDs, and dividend stocks a good investment right now. Because of low bond returns, many investors have already piled into dividend stocks. That ship sailed in 2009 and 2010. I’m personally having a hard time finding any good stock values.

Readers: What do you think are viable options to invest in not only a low interest rate environment, but also a increasing tax rate for dividends?

Comments

  1. David says

    “So it looks like we are expected a maximum 200% tax increase with dividends from the end of the Bush tax cuts alone. This isn’t including the Obamacare 3.8% increase with families whose overall income is above $250,000 (individuals with income over $200,000). All of this won’t bode well with investors and businesses who payout a dividend.”

    You mix percentages with percent points.

    http://xkcd.com/985/

    It is a huge increase though no matter how you slice it.

    • says

      Hi David, are you saying I’m not formatting the 200% correctly? Should it be listed as 200 percentage points? I knew it was a difference between the two tax rates, just unsure of the formatting. Thanks.

  2. says

    I like a mix of dividends and growth stocks/funds. I expect to live a very long time (roughly 30+ years)in retirement. I want to make sure I have sufficient money to support my wife and I for that long.

    • says

      @kratcents: I assume you have bought these dividend stocks years ago? I’m suggesting new money. What should someone invest in now for yield, that is someone safe, and also do better than the tax increases.

  3. says

    I would say P2P lending is a good alternative. 5% returns are easy to obtain. My personal portfolio is returning 13.4%, but is only 10 months old. It’s really not considered conservative though, in fact I did a poll for this on my blog a while back:

    http://www.nickelsteamroller.com/blog/2011/12/poll-do-you-consider-p2p-lending-a-conservative-investment/

    Only about 25% of this poll population finds it conservative. But the returns are stable and incredibly low in volatility. Unfortunately a lot of investors have caught on and it’s getting harder to invest in quality note in large quantities. Investing 50K could take a year if you adhere to a strict investing technique.

    One of the reasons I follow your blog is because you cover alternative investments. One investor that recently started to follow me on Twitter owns farms located all over the world. Now that is an alternative investment!

    • says

      Hi Michael,

      Yea I’m trying to cover alternative investments not discussed often, yet offer a stable return. The alternative investment universe is partly growing because of mentioned low FED funds rate.

      • says

        I spent a little time on tax liens too (read the book “The 16% Solution”). Its a waste of time, money and effort. This might have worked once upon a time. These days the government will just take your house and sell it for as much as they can instead of issuing a tax lien which is really quite insane.

        P2P lending is the best thing I’ve been able to find as of late. I don’t look at it like an investment though, I approach basically like a business. I am paying a 1% premium to use Prosper and Lending Club’s platform to run a loan business.

    • says

      To add to my comment, don’t you think it’s a good thing that it’s getting harder to large quantities? That means P2P lending is becoming more mainstream. Though as the amount of borrowers increase so should the pool size of available loans to choose from. I know Lending Club has actively contacted Walls Street firms to invest in their notes, so I’m sure we are competing against some quants.

      • says

        I think it’s great as well, but I also want to put an increasing portion of my pathetically performing portfolio to work in P2P .

        But if demand for borrower notes continues to be be high and demand is low, interest rates will be forced down. I’ve talk to both Prosper and Lending Club about getting on sites like Credit Karma and positioning themselves as a smarter alternative to credit cards to get more money coming in. Imagine applying for a “Prosper Card” instead of a Visa.

        Prosper already had to make changes to their API because institutional investors were buying every loan, in full as fast as they came on the market!

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