Investment Income - Don't Be ShortSighted
When choosing among investment alternatives where income is a primary consideration, conventional choices often include money market instruments, CDs, bonds, bond funds, unit investment trusts, and certain types of annuities. Notably absent from that list is the lowly dividend-paying, common stock. Because common stocks can be volatile, they are often excluded as a viable income solution. That could be a mistake.
While it is true that at any given point in time the yield of the typical dividend-paying common stock is likely to be significantly less than the yields that are available on competing income instruments, the story does not end there. Consider for a moment an investor who has a need not only for current income, but a need for that income to increase over time. Why might an investor need a rising income stream? Well, if the cost of living were to increase by 3% per year over a 20-year period, the purchasing power of a dollar would fall by about half. So, in 20 years that investor would need about two dollars of income for each dollar of income received today – just to break even!
Assume you had $1,000 to invest back in 1996 and you were trying to choose between a money market account*, or General Electric common stock. In 1996, the yield on that money market account may have been around 5% – more than twice the yield of GE’s common stock. Which would you have chosen?
If you were tempted to choose solely on the basis of the higher current level of income, you would have chosen the money market account. But unless you were convinced GE could not grow anymore, that decision would have been short-sighted. Take a look at the income that would have been produced by these two vehicles:
MM GE
1996 $51 $32
1997 52 37
1998 48 43
1999 48 50
2000 59 58
2001 33 65
2002 17 73
2003 11 78
2004 16 81
2005 34 92
$369 $609
Over this 10-year period, GE’s dividends would have started out slowly, but you would have received a raise each year en route to ultimately receiving 65% more income. And, your GE stock would have more than tripled in value.
This is not a commercial for GE stock because similar outcomes would have been possible for plenty of other stocks. The lesson is simple: When considering income alternatives, an often overlooked consideration is how that income might be expected to increase over time.
*Money market results approximated by Fed data on 6-month Treasury securities
