Bonds are Generating Real Income Again [VIDEO]

Investors can earn income in two ways – dividends paid on stocks and interest paid on bonds. While both generate income, stocks and bonds have remarkably different risk profiles. Stocks tend to be more volatile than bonds because stocks are more sensitive to the state of the economy and changes in a company's financial performance. Stocks also face a higher degree of income uncertainty since companies may choose, but are not obligated, to pay dividends to shareholders. In contrast, borrowers are contractually required to pay interest on their bonds at specified intervals. Bondholders also rank more senior in a company’s capital structure and are typically paid back before stockholders if a company declares bankruptcy. While bonds tend to produce lower price returns, their contractual interest payments and seniority may make them a less risky income source.

The last decade of low interest rates made it difficult for investors to generate income. If investors wanted to earn more income than bonds offered, they turned to the stock market for dividends. Figure 1 below tracks the number of S&P 500 companies with a dividend yield above the yield on a 5-year Treasury bond.

From 2008 through 2022, many S&P 500 companies offered higher yields than the 5-year Treasury bond. However, the situation changed considerably during the past 12 months as interest rates have risen. As of July 11th, only 51 companies in the S&P 500 paid a dividend yield above the yield on a 5-year Treasury bond. That’s the fewest number of  companies since 2007.

While bonds sold off in 2022 as the Federal Reserve raised interest rates, those interest rate hikes now present an opportunity for bond investors. Figure 2, which graphs the yield across various U.S. Treasury maturities, shows bonds once again are a meaningful income source. 

From a portfolio perspective, we are incorporating these developments into our bond allocations and our overall investment strategy.  If you would like additional insight or guidance, schedule a call by clicking the button below.

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