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2020 Vision: Yield Scarcity and the Case for Dividends

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 Index
30-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.


 

Recent Posts


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


Important Legal Information

For more information on any of our funds, contact your financial advisor or download a free prospectus. Investors should carefully consider a fund’s investment goals, risks, sales charges and expenses before investing. The prospectus contains this and other information. Please read the prospectus carefully before investing or sending money.

Past performance does not guarantee future results.

What are the risks?

Franklin Equity Income Fund
All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. The fund’s investment in foreign securities also involves special risks, including currency fluctuations and economic as well as political uncertainty. These and other risks are described more fully in the fund’s prospectus.

Franklin Balanced Fund
All investments involve risks, including possible loss of principal. The fund’s share price and yield will be affected by interest rate movements. Bond prices generally move in the opposite direction of interest rates. As the prices of bonds in the fund adjust to a rise in interest rates, the fund’s share price may decline. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. These and other risk considerations are described more fully in the prospectus.

Franklin Income Fund
All investments involve risks, including possible loss of principal. The fund’s portfolio includes a substantial portion of higher-yielding, lower-rated corporate bonds because of the relatively higher yields they offer. These securities carry a greater degree of credit risk relative to investment-grade securities. The fund’s share price and yield will be affected by interest rate movements. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in the fund adjust to a rise in interest rates, the fund’s share price may decline. Floating-rate loans are lower-rated, higher-yielding instruments, which are subject to increased risk of default and can potentially result in loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value. The fund is actively managed but there is no guarantee that the manager’s investment decisions will produce the desired results. These and other risk considerations are discussed in the fund’s prospectus.

Templeton Global Balanced Fund
All investments involve risks, including possible loss of principal. Special risks are associated with foreign investing including currency fluctuations, economic instability and political developments; investments in emerging markets involve heightened risks related to the same factors. To the extent the Fund focuses on particular countries, regions industries, sectors or types of investments from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a fund that invests in a wider variety of countries, regions, industries, sectors or investments. Current political uncertainty surrounding the European Union (EU) and its membership may increase market volatility. The financial instability of some countries in the EU, including Greece, Italy and Spain, together with the risk of that impacting more stable countries may increase the economic risk of investing in companies in Europe. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as the price of bonds in the fund adjust to a rise in interest rates, the fund's share price may decline. The risks associated with higher-yielding, lower-rated debt securities include higher risk of default and loss of principal. The fund's investment in derivative securities, such as swaps, financial futures and option contracts, and use of foreign currency techniques involve special risks as such may not achieve the anticipated benefits and/or may result in losses to the fund. The Fund's risk considerations are discussed in the prospectus.

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