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Yield-Hungry Bond Investors Take A Chance

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By JONATHAN CLEMENTS The Wall Street Journal

Published: December 2, 2007

If you're a bond investor hankering for higher yields, here's a radical suggestion: Try stocks.

Since mid-July, the Dow Jones Industrial Average has slumped 8 percent, bounced back 10 percent and then dropped another 10 percent, before rallying last week.

Yet, if you look beyond the wild stock-price swings, you will find shares are a remarkably reliable source of income.

Want an alternative to 10-year Treasury notes, with their skimpy 3.9 percent yield? High-yield stocks could be just the ticket.

Whipping inflation. Suppose you were born at year-end 1925 to affluent parents, who immediately bestowed $1 million upon you.

Let's assume they took the safe route, stashing the entire sum in Treasury bills and then left you to live off the interest. In 2006, your income would have been $48,000, versus $33,000 in 1926, according to Ibbotson Associates, a unit of Chicago investment researchers Morningstar. Trouble is, because of inflation, $1 of interest in 2006 had less than a tenth of the spending power of $1 in 1926.

Now, imagine instead that your parents rolled the dice and plunked the $1 million in large-company stocks. If you spent the dividends but didn't sell any shares, you would have pocketed a robust stream of income that climbed in 65 years and fell in just 15, Ibbotson calculates.

Even more impressive, your

$1 million would have ballooned to $111 million over the 81 years - and your income would have jumped from $54,000 in 1926 to almost $2 million in 2006. Indeed, your income would have grown at an average 4.6 percent a year, easily outpacing inflation's 3.1 percent.

Getting cut. Admittedly, buying stocks for income has its drawbacks. The broad U.S. market yields less than 2 percent so you will need to own high-yield shares if you want a healthy amount of income.

These high-yield shares are typically beaten-down "value" stocks. Value stocks, especially small-company value stocks, held up well through the 2000-02 bear market and then posted market-beating gains during the recovery that followed. But in 2007, the cycle has turned in favor of growth companies - and thus a high-dividend strategy could push you into value stocks at just the wrong time.

Relying on stocks for income will also leave you at the economy's mercy. "If this advice is wrong, it will be very wrong," warns Laurence Siegel, research director in the Ford Foundation's investment division.

Even if dividends hold up, you will need to shut your eyes to share-price swings. That's easier said than done. "The imaginary investor who doesn't care about price probably doesn't exist," Siegel says.

Banking dividends. For high-yield investors, the ride could prove especially nerve-racking. To collect handsome dividends, you often have to buy the market's least-loved companies.

For instance, financial planner Ross Levin likes high-yield stocks such as Bank of America, U.S. Bancorp, Wachovia and the exchange-traded iShares Dow Jones U.S. Regional Banks (IAT). "They look extremely cheap," argues Levin, president of Accredited Investors in Edina, Minn. "The only problem is, we don't know whether they'll get cheaper."

An added bonus: While a bond's yield is dunned at federal income-tax rates of up to 35 percent, qualified dividends are taxed at a maximum 15 percent.

Don't like the idea of betting just on bank stocks? You can get broader diversification with high-yield exchange-traded index funds.

These funds should yield 4 percent to 6 percent. Sound attractive for retirees? Given the risks, high-dividend stocks shouldn't be your sole investment. But if you're hunting for more income in today's low-yield market, they could be a choice for a chunk of your portfolio.

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