Berkshire Hathaway’s (BRK.A, BRK.B) 2020 letter to shareholders in its Annual Report shared Warren Buffett’s thoughts on bonds(bolding added for emphasis):
“And bonds are not the place to be these days. Can you believe that the income recently available from a 10-year U.S. Treasury bond – the yield was 0.93% at yearend – had fallen 94% from the 15.8% yield available in September 1981? In certain large and important countries, such as Germany and Japan, investors earn a negative return on trillions of dollars of sovereign debt. Fixed-income investors worldwide – whether pension funds, insurance companies or retirees – face a bleak future.”
Prior to the above quote, Buffett explains that Berkshire’s financially stable insurance operations can invest heavily in equities as opposed to bonds.
The Merits Of Bonds
We do think there are reasonable diversification purposes to holding bonds – specifically long-term bonds. Long-term T-bonds have historically had a low correlation to equities, which makes them useful for reducing portfolio volatility and likely buffering drawdowns in the event of a serious recession. An investment in long-term bonds could mean more funds available to purchase undervalued stocks when the next big market decline occurs. But that’s not to say today’s ultra-low bond yields look like good investments in and of themselves.
With today’s ultra low interest rates, reasonably safe bonds tend to offer very low expected total returns. Low expected total returns mean the investment isn’t doing a particularly good job of what investments are ultimately supposed to do – make money.
Dividend Growth Stocks
Fortunately for income investors, we believe there is a significantly better option for generating income – dividend growth stocks.
The big difference between stocks and bonds is that stocks give you actual ownership in the underlying business and standard bonds do not. With dividend growth stocks – while the dividend is not technically required – many have not only paid, but increased their dividend every year for decades. Stocks are able to pay rising dividends over time when the cash generating power of the business on a per share basis grows over time.
And as an added bonus, if the business (on a per share basis) is growing over time, then your shares are likely to appreciate in value over time. This is another advantage over bonds.
Interestingly, bonds often don’t even offer investors higher starting yields versus stocks in today’s market. Take AT&T as an example. The stock currently yields ~7%. The company issued 40 year bonds at a 3.85% rate – more than 3 full percentage points lower than the stock’s yield (which is also likely to grow, albeit slowly, over time).
The future for bonds may be bleak. Fortunately, dividend growth stocks provide a better alternative in today’s market for both current income and rising income over time.
The Sure Dividend Newsletter
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- Dividend Risk Scores of A or B
- Market beating expected total returns
- Dividend yields in excess of 2.0% (with most significantly higher)
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