The Bond Bombshell

The Motley FoolIt is said that as much as 90% or more of a portfolio’s return comes from asset allocation. In other words, a significant portion of your portfolio’s return could come from correctly mixing the amount of cash, bonds, property and shares that you hold.

But try telling that to Peter Lynch. Try telling that to Warren Buffett.

Anyone who would dare to suggest to the two investing legends that bonds are a better investment than shares is likely to be given short shrift – even if shrift might be in very short supply.

You can’t go wrong

Lynch’s views on bonds can be summarised in these three short sentences:

The reason that stocks do better than bonds is not hard to fathom. As companies grow larger and more profitable, their stockholders share in the increased profits. The dividends are raised.”

He went on to say: “The dividend is such an important factor in the success of many stocks that you could hardly go wrong by making an entire portfolio of companies that have raised their dividends for 10 or 20 years in a row.”

Buffett is well aware of the importance of dividends, too. He worked out a long time ago that buying dividend-paying stocks that have the ability to grow their payouts makes perfect sense.

In 2010, Buffett told Berkshire Hathaway shareholders that Coca-Cola (NYSE: KO) paid them $88 million in dividends in 1995. That was the year when he completed his purchase of stocks in the fizzy-drinks maker. Every year since, Coca-Cola has increased its dividend.

Perpetual-motion machine

By 2011, Berkshire Hathaway received $376 million from Coke, an increase of $24 million from the year before. He said he anticipated that the payout would double within ten years.

He went on to say that by 2020, his share of the annual earnings from Coke will be more than 100% of the price he paid for the investment.

How did that happen?

Many people, when they invest in income shares, tend to focus on the current yield. There is nothing too wrong with that. You want to make sure you get a decent bang for your buck.

However, if you can find shares that have the ability to raise dividends comfortably, consistently and continually, then you have probably found yourself the closest thing to a perpetual-motion machine.

As the dividends go up year after year, the yield on your original investment goes up year after year, too. It is called yield-on-cost. There is also a good chance that the shares could follow suit. Or put another way, you could get two bangs for your buck.

The rate at which the dividends rise does not need to be excessive – just a gentle rise will be fine. Here in Singapore, we don’t need to wander too far from the Straits Times Index (SGX: ^STI) to find examples of these types of companies. They include Keppel Corporation (SGX: BN4), Jardine Matheson (SGX: J36) and SingTel (SGX: Z74).

The key organ

Yield-on-cost is a simple concept but, nevertheless, it is a very powerful one. It demonstrates how dividends could slowly increase your wealth. And if you give the strategy enough time, it could also make you quite wealthy.

Just recently, a headline in the Business Times caught my attention. It said: “Choppy Equity Markets Push Investors To Bonds.

The bond-bombshell is an all too predictable reaction to market turmoil. We see it time and again.

The stock market, admittedly, can get quite ugly at times. Just look at what the conflict in Ukraine did to global markets. But we should never let short-term volatility cloud our judgement about investing for the long term.

Peter Lynch once said that the key organ when investing is the stomach. Everyone has the brainpower, he quipped, but not everyone has the stomach for it. He even joked that for many people, long-term investing is three weeks from next Wednesday. That is definitely not good for the stomach.

So take a good look at the stocks in your portfolio to see if they can stand the test of time. If you want to develop a strong constitution, focus on the next five, 10 or even 20 years. If you can do that successfully, then you could be in for quite a treat.

This article first appeared in Take Stock Singapore.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.