The recent downturn in interest has reignited the debate about whether investors can substitute dividend stocks for bonds.
A retired 58-year-old reader says she was recently told by a fee-for-service financial planner (paid an hourly or flat rate, doesn’t sell products) that her portfolio is overweight in stocks and needs more bonds. “I'm struggling with giving up my steady-Eddie dividend portfolio,” she wrote. “In this day and age of relatively low interest rates, what are your thoughts on portfolio composition as we move into retirement?”
Tough one. Conventional thinking is that a retiree’s portfolio should have a significant weighting in bonds to limit the damage when the stock market plunges. On the other hand, bond yields today are low and could fall further. Bonds are almost dead money if rates stay more or less level for a while. On an after-inflation basis, you’re probably losing money.
For reasons related to investor emotions, I come down on the side of having some bonds and not going with an all dividend stock portfolio. Even steady Eddie dividend stocks can get fried in a bear market. The risk here is that these stocks get sold at a market bottom by a nervous investor and the proceeds end up sitting in cash, which essentially means rotting.
The question is how much of a bond weighting. There’s an old rule that your weighting in stocks should be calculated as 100 minus your age, or 42 per cent in this particular example. A more modern take on this idea is to go with 110 or even 120 minus your age, or 52 and 62 per cent, respectively, in this example.
A 60-40 portfolio of stocks and bonds is worth considering for a 58-year-old. There’s enough of a bond weighting to help in a bear market, and enough stocks to generate the portfolio growth a 58-year-old is going to need through the decades of retirement ahead. It might be OK to add go 70-30 stocks and bonds if an investor has a defined benefit pension or is highly disciplined in terms of understanding that stock market crashes directly affect the share price of a dividend stock, not the flow of quarterly dividend income.
One last word in defence of bonds right now: Returns over the past year might be better than you think as a result of declining rates. When you combine interest payments with capital gains based on rising bond prices, you get a 12-month total return of 3.6 per cent for the FTSE TMX Canada Universe Bond Index. Note: Bond prices move in the opposite direction of rates.