If you could choose between an investment that offers a 4%-plus yield and one with a 3% yield… which one would you pick?
On the surface, the 4% yield obviously looks better than the 3%.
But when comparing where those yields are coming from and the kinds of investments behind them… you’ll notice how one shines over the long term and the other stays the same.
As interest rates rise, I’m seeing investors flock into fixed-income investments as they search for safe and reliable passive income.
This isn’t surprising… For the first time in over a decade, U.S. 2-year and 10-year bonds finally offer yields over 4%.
At Intelligent Income Daily, we’re also income-oriented investors. And we have to admit, a risk-free 4% yield is very attractive… But I still believe there’s a better option for long-term investors looking to boost their income streams.
Today, I’ll show you what that alternative is and how it can help you compound your wealth in ways that just aren’t possible with fixed income assets like bonds.
When you compare the risk and reward, I’m sure you’ll agree: These investments deserve a spot in your portfolio.
Long-Term Growth Wins Out
Let’s start with a hypothetical example. And for the purpose of this essay, we’ll focus on passive income instead of other valuation metrics.
Say you had $10,000 to invest, and you were looking for a safe income play that would grow your capital.
You put it to work buying U.S. 10-year bonds, which currently yield 4.2% annually. That’s their highest level since 2007.
Assuming you hold this bond for the duration of the decade, in 10 years, you will receive your $10,000 back. And on top of that, you will have generated $4,200 in passive income.
In short, you turned $10,000 into $14,200 with minimal downside risk.
Not too bad, right?
But look what could have happened if you put that same $10,000 into a dividend stock – even one with a lower yield – over those same 10 years…
Let’s say you bought a dividend growth stock with a 3% yield, a stable 7% fundamental growth rate, and therefore, an expected dividend growth rate of 7% per year.
That 4.2% bond yield is 40% higher than the 3% dividend stock yield. So you might assume the 10-year bond would pay out more passive income over the next decade in this situation…
However, assuming the equity hits those fairly conservative long-term growth targets, that wouldn’t be the case. Comparatively, the S&P 500 has posted 10% annual growth for the last nine decades.
Over a 10-year period, that 3% yield – compounding 7% every year – would produce $5,941.38… That’s 41.6% more passive income than the fixed income investment.
At the end of the 10th year, the annual dividends generated by this blue-chip stock would have been $1,031.98 (well above the $420 the fixed-income bond paid out – the same as it did in the first year).
In other words, the investor who bought the dividend growth stock would have a yield on cost north of 10% at the end of this 10-year period. Meanwhile, the bond investor – who was not benefiting from organic dividend growth – would still be looking at that fixed 4.2% yield.
Furthermore, assuming the stock’s underlying share price compounded at a rate in-line with its fundamental growth rate (which tends to happen with strong blue-chip stocks over long periods), that original $10,000 would have transformed into $19,671.51.
Therefore, with dividends included under the second scenario, your total returns would be more than 250%… crushing the 42% returns generated by the 10-year bond.
Blue-chip companies tend to reliably grow their dividends over time. This dividend growth snowballs, and it doesn’t take long for the income they produce to accelerate. And that’s how they beat out fixed-income investments.
You’ll see that when comparing risk and reward between fixed-income assets and blue-chip dividend growth stocks… dividend yields have a much better setup than bond yields.
The Key Is to Find the Best Dividend Payers
Before I go any further, I will say no dividend is ever 100% safe or guaranteed. All equities are risk assets and therefore, there’s no sure thing in the equity space.
But, historically speaking, there are hundreds of companies that have paid reliably increasing dividends for well over a decade. That’s why I continue to believe we can find strong companies with solid fundamentals and wide moats that will provide investors with predictable passive income over the long term.
For a full list of my favorite dividend-paying stocks, click here to learn more.
Sure, there’s always risk when holding equities. But at the end of the day, I continue to sleep well at night holding blue-chip stocks like the ones on that list. They’ve proven themselves capable of generating outsized returns, again and again, year after year.
And I’m confident they’ll continue doing so decades into the future.
Happy SWAN (sleep well at night) investing,
Editor, Intelligent Income Daily