During the 25 years prior to 2009, investment income was ridiculously easy to come by. Doing something as simple as buying a 3-month Treasury bill produced an average yield of nearly 5%. That all changed, however, in late 2008, when yields dropped.

Since then, investors looking for income have had to become more creative, and many have looked to equities for income.

But with the bull market now more than 5 years old, you may be wondering whether this approach still makes sense. My answer: Yes, assuming you can take the volatility and look beyond U.S.-focused funds.

To be sure, as I pointed out in a recent post, I’d be wary of seeking income at all costs and ignoring valuation. In other words, asset class cross-dressing, or using stock portfolios to generate income while simultaneously building equity-like exposure in bond portfolios, is becoming risky in some scenarios.

However, there are segments of the dividend space that still look interestin: international and global dividend stocks. Here are two reasons why:

Stocks are still cheaper than bonds. While stocks are no longer cheap, they are cheaper than bonds. One way to measure this – particularly for investors focused on income – is to compare the yield available from a bond fund to the yield available from an equity alternative.

Since 1995, the dividend yield on a broad global benchmark (the MSCI World) has, on average, been 40% of the yield generated from an investment-grade bond index (Moody’s Aaa). Today the ratio is closer to 60%, as the figure below shows.

Chart

While this is below the record of 80% recorded two years ago, it still compares very favorably with the norm. In addition, equities have three additional advantages over bond alternatives: tax treatment favors dividends, stocks have the prospect for future capital gains and stocks can provide a better inflation hedge.

International dividend funds look cheaper than U.S. focused funds. While stocks offer better value than bonds, I would bring up exposure to international and global dividend funds rather than focus exclusively on U.S. dividend funds, which look more expensive. Reflecting this fact, dividend yields in the United States are low compared to the rest of the world. The S&P 500 yields roughly 1.9% versus 3.3% for other developed market stocks (MSCI World ex-USA Index) based on World ex-US and 2.70% for emerging market equities (MSCI Emerging Markets Index).

At less than 2%, the current U.S. dividend yield not only looks relatively low compared to the rest of the world, but it also looks low compared to its own history. And while the yield on U.S. equities is close to its long-term average, the yield on other developed market stocks is nearly 30% higher than the norm.

Still, there’s no getting around the fact that stocks are no longer cheap. Given current valuations, I would expect returns over the next five years to be substantially lower than the previous five.

In addition, investors need to remain mindful of risk. While stocks are cheaper than bonds, equities generally come with more volatility. Today the case for equities as a dividend source comes down to relative value: Stocks are cheaper than bonds while simultaneously providing some upside potential.

The bottom line: For investors looking for income, international and global dividend funds are still a reasonable choice, at least given the alternatives.

Sources: BlackRock, Bloomberg

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog and you can find more of his posts here.

There is no guarantee that dividends will be paid

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/ developing markets or in concentrations of single countries.

iS-13111

?feed-stats-post-id=19271

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: WisdomTree International LargeCp Div

    Learn more about the WisdomTree International LargeCap Dividend fund, an income-based international equities ETF that focuses heavily on the United Kingdom.
  2. Mutual Funds & ETFs

    ETF Analysis: First Trust Dow Jones Global Sel Div

    Find out about the First Trust Dow Jones Global Select Dividend Index Fund, and learn detailed information about characteristics and suitability of the fund.
  3. Investing Basics

    Understanding How Dividends Are Taxed

    Learn how dividends are taxed by the IRS, and understand the different types of dividend income as well as the capital gains tax rates.
  4. Investing Basics

    6 Reasons Why Dividends Should Be Reinvested

    Learn about the advantages of dividend reinvestment programs and how they may benefit longer-term investors who want to build a position in a company.
  5. Options & Futures

    Understanding How Dividends Affect Option Prices

    Learn how the distribution of dividends on stocks impacts the price of call and put options, and understand how the ex-dividend date affects options.
  6. Mutual Funds & ETFs

    ETF Analysis: Utilities Select Sector SPDR

    Learn about the Utilities Select Sector SPDR ETF and the benchmark index it tracks, and understand what type of investors may be interested in the fund.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares International Select Dividend

    Learn how the iShares International Select Dividend ETF provides investors an opportunity to gain exposure to high-quality companies outside the United States.
  8. Investing Basics

    How Do You Find Penny Stocks That Pay Dividends?

    Learn about how investors can use online stock screeners to obtain a list of dividend-paying penny stocks for their consideration.
  9. Investing News

    Understanding How Mutual Funds Pay Dividends

    The process by which mutual fund dividends are calculated, distributed and reported is fairly straightforward in most cases. Here's a look.
  10. Fundamental Analysis

    Bet on this U.S. Automaker for Long-Term Gains

    Ford holds a stronger technical position than General Motors and also pays a consistent dividend. This combination could mean greater 3-to-5-year returns.
RELATED TERMS
  1. Record Date

    The cut-off date established by a company in order to determine ...
  2. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends ...
  3. Dividend

    A distribution of a portion of a company's earnings, decided ...
  4. Target Payout Ratio

    A target payout ratio is a measure of what size a company's dividends ...
  5. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  6. Sucker Yield

    When an investor has essentially risked all of his capital for ...
RELATED FAQS
  1. Are dividends considered passive or ordinary income?

    Despite the fact that earning dividends requires no active participation on the part of the shareholder, they do not meet ... Read Full Answer >>
  2. Is dividend income taxable?

    Dividend income is taxable but it is taxed in different ways depending on whether the dividends are qualified or nonqualified. ... Read Full Answer >>
  3. How do dividends affect net asset value (NAV) in mutual funds?

    Distribution of dividends reduces the net asset value (NAV) of mutual fund shares. However, this doesn't mean that fund investors ... Read Full Answer >>
  4. How do dividends affect the balance sheet?

    Dividends paid in cash affect a company's balance sheet by decreasing the company's cash account on the asset side and decreasing ... Read Full Answer >>
  5. Who actually declares a dividend?

    It is a company's board of directors who actually declares a dividend. The declaration date is the first of four important ... Read Full Answer >>
  6. Where exactly do dividends come from?

    Companies pay dividends in cash, which typically come from the companies' cash flows from operations by selling goods and ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!