Dividend Investing: The Yield Gap

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Sep 01, 2011

Dividend Investing: The Yield Gap

The aim of dividend investing is to provide a reliable stream of steady cash inflows.

Investors like Warren Buffett who really take a long-term view on their investments reap the most benefits of dividend investing.

Consider Buffett’s investment in The Washington Post (WPO, Financial) which now generated a massive yield of 153% on the initial investment. Likewise Buffett’s Coke (KO, Financial) investment now yields around 30% on his initial investment.

The ideal time to start a dividend portfolio is when the yield gap is positive.

The yield gap is the average gross yield on equities less the annual yield on long dated bonds.

Usually the yield gap is negative as bonds return a higher yield than the average yield on equities. However, in depressed markets, such as the one we find ourselves in now, the yield gap turns positive.

This means that equities return a higher yield than long dated bonds. It also means that the investor should be able to purchase equities which are trading on historically high dividend yields.

Such purchases of stock, where the dividends are at historical high levels, give the investor larger returns quicker. However, it is over the long term that such purchases really make a difference as compounding takes effect.

A good place for starting research for potential dividend stocks is the Dividend Aristocrat list, or for foreign stocks the S&P Euro 350 Dividend Aristocrat list is a worthwhile starting point.

Of course dividend stocks may be purchased when the yield gap is negative. However, the dividend yields will most likely not be at historical high levels.

Some reasons why investors purchase dividend stocks when the yield gap is negative are:

· Investors expect that dividends will grow over time. Historically dividends from most well operated companies grow faster than inflation.

· Investors expect to receive a capital gain from their investment in equities.

· Bond returns are fixed and so are subject to inflation increases.
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