Inflation and dividends

Fortune talks to four investment experts about where they think sensible money should go in the next decade for long-term investment purposes (link). In my view, Bill Gross makes the best recommendation. Interestingly, he fails to talk his own book; Gross is a bond fund man, but advises against bonds and for income stocks:

Focus on dividend income in terms of stocks, as opposed to growth and investment-grade income from bonds. You can generate a portfolio that yields 4% to 5% and that is in some fashion protected against inflation. (src)

In fact, I would say that this isn't simply where sensible money should go in the next decade, it is where the sensible money has always gone: into businesses which are not simply profitable but cash-generative, and which consistently return a good portion of the cash they generate to their investors.

The rough index-linking is a point people sometimes miss, I think. Dividends are a discretionary payment, but sustainably increased profits do generally result in an increased dividend payment. From what I have heard of the Barclays Capital Equity Gilt Study, it seems that this theoretical result can be found empirically in the history books: a BarCap advertising note, which I assume uses the BarCap research, claims that capital has posted about 0.5% annual growth, and dividends an even more modest 0.1% growth (src). Certainly, yields have not experienced a shift of anything like an order of magnitude, which is consistent with both capital and income roughly tracking inflation.

Index-linked bonds are one way of generating inflation proofing, but they are expensive for the income they generate. If the time period is sufficiently long that something a bit more volatile and a bit less guaranteed could be used instead, then a tracker of one of the large UK indices might be worth some thought.

(Via FT Alphaville.)