With interest rates at historic lows, investors holding cash and cash-equivalents have found themselves in a bind. Faced with low returns, many investors are looking for an alternative. There are many different solutions to this problem, but we think it may make sense to take a closer look at mutual funds that pay a dividend and include exposure to equities.
Corporate Cash: A Catalyst for Dividends and the Economy?
If you've been visiting this page regularly, you've already read about what an historically low dividend payout ratio could mean for dividends in the future.
Another potentially positive sign for future dividends is the record level of cash on corporate balance sheets. The recession caused some companies to struggle, but other companies used it as an opportunity to reduce expenses and strengthen their balance sheets to ensure they weathered the storm.
As a result, in 2012 and into the fourth quarter of 2013, many companies accrued record levels of cash. We can't say exactly how all this cash will be put to use, but experience tells us it won't sit on the balance sheet forever. It will be put to work somehow, and that could take a number of different forms. It could be invested in new factories or new hiring, which could help the economy expand and be a boon to equity investors. It could be used to buy back stock, which could also help equity investors. Or it could be paid out as new or increased dividends, which again could benefit equity investors who are the recipients of those dividends.
We're not trying to predict how the cash would be used, but we're optimistic about what all this corporate cash could mean to the economy and to investors who have some exposure to equities in their portfolios.
Our hybrid funds (listed at right) are one way for investors keeping cash on the sidelines to add some exposure to equities and earn current income in the form of dividends at the same time.
Will Cash on Corporate Balance Sheets Fuel the Next Expansion?
S&P 500 Companies' Total Cash as a Percentage of Total Assets
Source: Ned Davis Research, Inc. Most recent data is through 12/31/2013.
Historical Norms Suggest Dividends May Be Poised to Increase
Here's a stat that may not be on the radar of the typical investor: dividend payout ratio.
This ratio measures the percentage of a company's earnings that are paid to shareholders in dividends. It's calculated using this formula:
Dividend Payout Ratio = Dividends Paid to Shareholders ÷ Company Earnings
Why is it important now?
Well, if we look at the dividend payout ratio of companies in the S&P 500 Index, the long-term average is 51%. However, at the end of fourth quarter of 2013, it was much lower at 38%.
If you're familiar with the expression "history favors a return to the mean" you understand why the current low dividend payout ratio is intriguing. With companies currently paying out a smaller percentage of their earnings as dividends, there may be potential for increases if the dividend payout ratio returns to its long-term average.
Historical Norms Suggest Dividends May Be Poised to Increase
Dividend Payout Ratio of Stocks in S&P 500 Index30-Year Average vs. 2013, period ended December 31, 2013
Source: Compustat via FactSet. Indexes are unmanaged, and one cannot invest directly in an index. Past performance does not guarantee future results.
Low-Yielding Investments Can Threaten Purchasing Power
If you look at the average money market account yield over the past 10 years, you'll see that while the yield bounced between one and two percent from 2002 through the first quarter of 2008, it's been close to zero over the past four years.
Investors may be surprised to learn that once inflation is factored in, investments they may consider "more secure" while they wait out stock market volatility could actually be eroding their purchasing power.
Over the past 10 years, yields on an after-inflation basis were only positive for a total of 16 months. And, during 2009, absolute yields were very close to zero, and the "positive" yields were largely due to an 8-month period of deflation.
Historically, equities have been a good asset class for keeping pace with inflation over the long term. Investors concerned about the threat posed to purchasing power by low-yielding investments may want to consider funds that invest in dividend-paying equities.
Is the Yield on Your Money Market Account Actually Negative?
Money Market Accounts' Average Yields Before and After Inflation
for the 10-Year Period Ended December 31, 2013
This chart is for illustrative purposes only and does not reflect the performance of any Franklin, Templeton or Mutual Series fund. Sales charges, fees and expenses are associated with Franklin Templeton fund investments, which reduce investment returns. Fund investment returns and share prices will fluctuate with market conditions, and investors may have a gain or a loss when they sell their shares. Money market accounts are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000. Sources: BanxQuote and the Bureau of Labor Statistics. Inflation is represented by year-over-year changes on a monthly basis of the Consumer Price Index (CPI). Past performance does not guarantee future results.
The Ugly Truth: Record-Low Yields Won't Buy Much Living
Market volatility may have led many investors to flee the stock market into other investments such as money market accounts, CDs and Treasuries. The historically low Fed Funds rate, along with increased demand for Treasuries, has helped drive down the yields these fixed income investments offer.
Just how low is low?
If you invested $10,000 in a money market account on December 31, 2013 at the current rate for one whole year, you'd earn $2, or about the cost of a small latté at your favorite coffee shop.
A 1-year CD would provide less than $9, or about the cost of a night at the movies (not including popcorn).
10-year Treasuries would give you just over $290, or about the cost of a trip to the grocery store.
That's not a lot of return on your money. And that's why investors seeking yield may be better served by considering funds that invest in dividend-paying equities.
Will Low-Yield Investments Produce the Return You're Looking For?
1-Year Return on $10,000 Invested in a Money Market Account, CDs,
and Treasuries as of December 31, 2013
This chart is for illustrative purposes only and does not reflect the performance of any Franklin, Templeton or Mutual Series fund.
It's important to note that Money Market Accounts and CDs are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per owner. Treasuries, if held to maturity, offer a fixed rate of return and fixed principal value; their interest payments and principal are guaranteed. Fund investment returns and share prices will fluctuate with market conditions, and investors may have a gain or a loss when they sell their shares. Sources: Money Market Accounts and 1-Year CDs: BanxQuote; 10-Year Treasuries: The Federal Reserve H.15 Report.
Past performance does not guarantee future results.
What Are the Risks?
Investing in dividend paying stocks involves risks. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Companies cannot assure or guarantee a certain rate of return or dividend yield; they can increase, decrease or totally eliminate their dividends without notice. A fund's investment return and principal value will fluctuate with market conditions, and it is possible to lose money.
Funds to Consider with Your Advisor
Seeks to maximize income, while maintaining prospects for capital appreciation, by investing in a diversified portfolio of dividend-paying stocks, bonds and convertible securities.
Seeks both income and capital appreciation by investing in a combination of stocks, convertible securities and fixed income securities.
Seeks to maximize total return by emphasizing high current income and long-term capital appreciation, consistent with reasonable risk. The fund invests at least 80% of its net assets in equity securities (including securities convertible into common stock) and up to 20% of its net assets in debt securities.
Seeks both current income and capital appreciation by investing in global bonds and equities, and offers a dynamic, bottom-up allocation process.