A Better Place for Big Income

A lot of investors, particularly those who got started buying tech stocks back in the 1990s, have recently started thinking about the virtues of bonds for the first time ever.

It's easy to see why. If recent events are any guide, stocks can blow up pretty much at any time, shedding huge chunks of value in a matter of hours. Bonds, on the other hand, just kinda … sit there, paying income. Sure, bonds get traded on secondary markets, but while they can go up and down in price, those changes seldom amount to much.

Is that a yawn I hear?
Putting part of your long-term portfolio in bonds to reduce the excitement factor might be exactly what you need right now, for both anxiety-management and asset-allocation purposes.

Perhaps you've checked out something like Vanguard Intermediate-Term Bond Index Fund (VBIIX). As I write this, it would give you about a 5% yield. It buys a mix of government and "investment grade" -- BBB rating or better -- corporate bonds that have between five to 10 years left before maturity. The yield is okay, but don't expect huge total returns: In a good year, it'll return 6%-7%; for the last 12 months, it's up around 1.3%.

Exciting, eh? Yeah, I don't think so, either. Fortunately, there's another option, one brought to us by the very same market collapse that got us talking about bonds in the first place.

Once-a-half-century high yields
In this month's issue of the Fool's Rule Your Retirement newsletter, advisor Robert Brokamp points out something I'd missed in the noise of the last few weeks. For the first time since 1958, the yield on the S&P 500 -- we're talking about stock dividends here -- now exceeds the yield on a 10-year Treasury. Many individual stocks will even beat that Vanguard fund's yield -- with far greater possibilities for total return once the market starts to recover. Here are a few I turned up in a CAPS screen just now:

Source: Motley Fool CAPS. Data as of market close on Dec. 4.

As Brokamp notes, recent price drops have led to some amazing opportunities. If you're willing to hold for a few years -- through whatever turbulence the market throws at us -- you could make out very well indeed, with solid income now and capital appreciation later.

But as he also notes, finding the good stocks is a challenge.

Dividend investors, caveat emptor
If you use a stock screener to turn up companies with high dividend yields, as I did above, you will find many that look very attractive at first glance. Don’t rush to buy any of them until you're sure you understand the whole story. Some stocks have low prices for a reason. Some may have already suspended their dividend payments … something you won't learn from a stock screener.

And sometimes those dividends are bad news. Companies occasionally borrow money to make dividend payments in order to keep Wall Street thinking that things are better than they really are. Others may fund payments with money they should really be spending elsewhere.

General Motors (NYSE:GM), for example, paid a $0.25 quarterly dividend up until May. Yes, May 2008. Yes, that General Motors. That's about $153 million every quarter, money they could have been spending on … oh, I don't know, rushing desperately-needed new models to market, maybe?

In truth, that probably wasn't quite as stupid a decision as it sounds, at least from management's perspective. GM management has a complex and difficult relationship with the UAW, which functionally represents the interests of GM retirees along with workers, and many retirees own GM stock and counted on those payments … but that's all beside the point. GM's dividend yield was a tasty-for-the-time 5% when the company made its last payment in May, but the dividend alone would have been a supremely bad reason to buy the stock.

There are other risks and considerations to be aware of, like sustainability of dividends, and the pros and cons of buying now versus waiting a while longer. Brokamp walks through all of them in his article. If you're not a Rule Your Retirement subscriber, and you'd like to read the whole thing, just click here for a complimentary 30-day pass. Signing up takes just seconds, and you'll have full access for 30 days, with absolutely no obligation to subscribe.