by Ben Carlson, A Wealth of Common Sense
There were a couple pieces of advice given in yesterdayâs Wall Street Journal that I thought deserved a closer look. First up, Bank of America is recommending dividend stocks as a fixed income substitute because bonds yields are so low:
Bank of America recommends âhigh-qualityâ stocks that have growing dividends. These stocks benefit from a low-rate landscape because their regular cash payout ratios are, in some cases, higher than those of bonds or investing in the S&P 500 as a whole.
They continued:
Even if the Fed increases rates this year as much of Wall Street is calling for, Bank of America says high-yielding stocks will not be severely hurt. âThe difference in yield between stocks and bonds is wide enough that bond yields would have to rise significantly before they provide competitive yields to many equities.â
If your only critera for an income-producing investment is the yield youâre going to be in for a big surprise at some point. You canât just look at the absolute level of the yield when comparing stocks and bonds. Theyâre two completely different asset classes. A bad day in the stock market is a bad year for intermediate maturity, high quality bonds.
From the peak in late-2007 to the bottom in early-2009, the iShares S&P Dividend ETF (SDY) was down nearly 55%. In that same time the iShares Aggregate Bond ETF (AGG) was up around 8%. On the other  hand, when interest rates rose in 2013, AGG was down about 3% on the year.
Your stock yield is not going to protect you in the event of losses.You always have to think in terms of total return when thinking about income investments, not just the dividend or bond yield.
The second piece of advice comes courtesy of Wells Fargo on long/short hedged equity allocations to a portfolio:
Historically hedged-equity, or long-short, strategies perform best when markets are volatile and in periods when the values of different stocks move less in lock step. âRight now we think weâve entered into a period of both, which is a perfect environment,â said Adam Taback, head of global alternative investments at Wells Fargo Investment Institute in Charlotte, N.C.
Last year, his research unit recommended hedged-equity strategies only for the most aggressive clients. This year it favors a 3% to 6% hedged-equity strategy allocation across most client profiles.
Earlier this week I said investors should always have a reason for every allocation in their portfolio. This gentleman thinks this is the perfect environment for a hedged-equity strategy. But if youâre going to hedge then hedge. What good does 3-6% of your portfolio do for you in a hedged-equity product?
Well, it canât hurt, right?. It sounds reasonably intelligent to clients. If something goes wrong, weâve covered all of our bases. This is really just a smoke screen. If you really want to hedge out some of your equity exposure then just do it. A 3-6% allocation in a portfolio is not a hedge, itâs a copout.
It gives you a false sense of safety and security but really makes no difference from a diversification perspective. Checking every single box when it comes to a wide range of strategies sounds great in theory, but it can get overdone. Diversified portfolios donât need to hold a little bit of everything. In fact, you could argue that too much diversification is a bad thing at a certain point when you start adding things just for the sake of adding them.
As an investor you should be saying no to way more investment opportunities then you say yes to. Just because somethingâs available doesnât mean itâs necessary.
Sources:
Morning Moneybeat: Hereâs Where to Find Yield (WSJ)
Some Advisers Turn to Hedged-Equity Strategies in Choppy Markets (WSJ)
Further Reading:
Itâs Not a Chase For Yield, Itâs a Chase for Fees
Doing Nothing is a Decision
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