Bonds retain appeal, despite rock-bottom yields

8:44 am | August 6, 2012

WASHINGTON (AP) — Bond yields are scraping along at record lows, but investors keep buying them, valuing the modest, fixed returns they pay over the bigger potential profits offered by stocks.

Bill Gross of PIMCO, perhaps the nation’s best-known bond fund manager, said people should think long and hard before buying stocks at all. Gross declared in a letter last week that “the cult of equity is dying.” Investors have come to expect more growth from stocks than they can possibly deliver, Gross said.

Some strategists say they’ve seen this movie before, and investors are setting themselves up for disappointment if they avoid the stock market completely in favor of bonds. Profits from bonds are so meager, they say, that a portfolio of carefully chosen stocks would be a better bet than sticking only with fixed-income investments.

If you opt for bonds, “you’ll never make more income than what the bond yield pays,” says Margie Patel, managing director and senior portfolio manager with Wells Capital Management, a division of Wells Fargo. At least with stocks, she says, there’s a far greater possibility that the value of the investment will appreciate, in addition to any income you may get from dividends.

For investors brave enough to ride out the market’s current bout of volatility, “you’d do no worse on an income basis than with very conservative fixed-income investments,” such as high-rated corporate bonds, Patel says.

As an example, consider a Microsoft bond due in 2021, which currently pays a yield of 1.6 percent. For every $1,000 invested in the bond, the holder gets $16 in income every year.

That’s less than the dividends an investors would collect from dividends on Microsoft stock. Microsoft’s dividend yield at current prices is 2.7 percent, so a $1,000 investment would generate $27 in dividend income every year.

Another point in favor of dividend-paying stocks: Companies are paying out a relatively low portion of their money in dividends, compared to historical averages, Patel says — about 28 percent of their available cash.

One big reason that bond yields are so low is the Federal Reserve. The central bank has bought trillions of U.S. government bonds and mortgage-backed bonds to keep interest rates low.

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