Naturally, skittish investors may be tempted to plow their money into the safety of bonds. Before you do that, though, consider that bonds may not be as safe as you’d think, and that these dividend stocks may be just what you need instead.
The ‘safety’ of bonds
Investors flock to bonds because they are supposedly safer than stocks. And, since bonds hold a superior position to equities on the corporate financing ladder, bondholders are the first claimants to a company’s cash flow.
Remember, though, that there’s always a cost. In the case of bonds, the costs of contractually assured interest payments are high.
First and foremost is that fact that generally, it’s a mistake to view bonds as risk-free. Bonds have a price like any other security, which will fluctuate. Bond prices are especially vulnerable to rising interest rates, which we may be about to embark on. Since yields and prices are inversely related, bonds will sell off in times of rising interest rates.
Secondly, although interest payments take precedence to the residual claimant status of equity holders, a coupon does not increase over time. In other words, bondholders will not see their interest payments increase throughout the life of the bond—hence the phrase ‘fixed income.’
Therefore, interest from bonds loses purchasing power to inflation over time.
The solution? Dividend stocks
This is where the beauty of dividend stocks comes in. If you own shares of world-class dividend stocks such as Johnson & Johnson (NYSE:JNJ), or Exxon Mobil Corporation (NYSE:XOM), or The Coca-Cola Company (NYSE:KO), you will not only receive dividends, but likely capital appreciation as well, since these companies have historically done a fantastic job of increasing sales and profits over time.
And, even better, dividend payments tend to rise over time, and that’s especially true if you pick companies successful enough to stand the test of time, such as these three.
Johnson & Johnson (NYSE:JNJ) has diversified business segments, which include pharmaceutical drugs, medical devices, and several consumer healthcare brands that are in nearly every household in America, including Band-Aids and Listerine.
Johnson & Johnson (NYSE:JNJ) grew its sales and diluted earnings per share by 3% and 10% last year, respectively, indicative of how strong the company’s brands are. Furthermore, Johnson & Johnson (NYSE:JNJ) has a fantastic track record of returning a hefty dose of profits through to shareholders.
In April, Johnson & Johnson (NYSE:JNJ) provided investors with an 8% dividend boost. This marked the 51st consecutive year of dividend increases.
Meanwhile, Exxon Mobil Corporation (NYSE:XOM) has evolved from its humble beginnings as Standard Oil to become one of the world’s biggest companies with a market value in excess of $400 billion.
Last year, Exxon Mobil Corporation (NYSE:XOM) grew its diluted EPS by 15%, representing yet another year of strong growth from the global energy giant.
Even better, over the past few decades, Exxon Mobil Corporation (NYSE:XOM) has committed itself to raising its shareholder payout on an annual basis. To that end, Exxon Mobil increased its dividend by 21% in 2012 and then again by 11% early this year.
This year’s dividend bump represented the 31st consecutive annual dividend increase from Exxon Mobil Corporation (NYSE:XOM). According to the company, its dividend has grown by 6% compounded annually over the past 30 years.
To illustrate the outstanding financial position that both Johnson & Johnson (NYSE:JNJ) and Exxon Mobil are in, consider that they are two of the four publicly traded companies that hold the coveted triple-A credit rating from Standard & Poor’s.
The Coca-Cola Company (NYSE:KO) is a legend in its own right, counting Warren Buffett, one of the most famous investors of all time, as a financial backer.
The Coca-Cola Company (NYSE:KO) is about as steady as it gets. The company grew 2012 sales and diluted EPS by 3% and 6%, respectively, versus the prior year.
And, even better, the company isn’t shy about sharing its success with shareholders. Earlier this year The Coca-Cola Company (NYSE:KO) raised its dividend for the 51st year in a row.
The Foolish takeaway
The bottom-line is this: even though bond payments are more guaranteed than dividend payments, there’s a steep cost to this perceived safety. Bondholders will lose in times of inflation, as those coupons will lose purchasing power.
Dividends, on the other hand, rise along with profits over time, thereby insulating equity holders against the ravaging effects of inflation.
Bonds have their place in a conservative investor’s portfolio, but if the goal is long-term wealth creation, there’s simply no better place to park your cash than in highly profitable stocks such as Johnson & Johnson (NYSE:JNJ), The Coca-Cola Company (NYSE:KO), and Exxon Mobil Corporation (NYSE:XOM). These companies have pumped out increasing profits for decades on end, and have paid shareholders regularly increasing dividends along the way.
If you have a desire for income but also want to protect yourself against rising prices, then dividend stocks are the place to be. J&J, The Coca-Cola Company (NYSE:KO), and Exxon Mobil are each excellent companies that deserve a place in every Foolish portfolio.
The article Why You Should Buy Dividend Stocks Instead of Bonds originally appeared on Fool.com and is written by Robert Ciura.
Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Robert is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
