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With the 10-year gilt yield standing at 4.4pc, many income investors may currently be contemplating the sale of dividend shares to buy bonds.
After all, bonds are inherently less risky than stocks. Not only is there a lower threat of permanent capital loss, but their coupon payments are fixed and therefore provide a stable income.
Dividends, by contrast, can be cut, suspended or cancelled. And with the FTSE 100’s yield amounting to a rather humdrum 3.8pc, bonds offer a competitive income return.
The problem for investors, though, is that there is much more to income investing than yield, risk and stable payouts. Shares, while lagging bonds in at least some of these areas, have the one thing that bonds fail to offer: income growth potential.
Indeed, it is not particularly difficult to unearth companies that have generated inflation-beating dividend growth over the past five, 10 or 20 years.
Certainly, the task of generating real-terms dividend growth is far more difficult today, while inflation is significantly above target, than it has been for several decades.
But over the long run, a diverse portfolio of equities is very likely to produce an inflation-beating rise in dividends.
The importance of income growth is often overlooked by investors. In Questor’s view, it matters at least as much as obtaining a worthwhile yield, if not more.
Coupon payments from a 10-year gilt, for example, will gradually become worth less over time as price rises for goods and services persist.
Ultimately, this will lead to a lower standard of living for its holder.
By contrast, income growth from a diverse portfolio of shares is likely to result in an improved standard of living as dividend increases beat inflation over the coming years.
Shares also offer far greater scope for capital growth than bonds. Although it is possible to buy and sell bonds at a profit – especially during a period of interest rate cuts that have a positive impact on bond prices–the stock market’s track record is far more appealing from a capital growth perspective than that of fixed income assets.
Indeed, with interest rates likely to fall as inflation undershoots the Bank of England’s 2pc target over the coming years, according to its own forecasts, share prices are set to be positively catalysed to a far greater extent than bond prices.
In turn, an improving economic outlook prompted by a more accommodative monetary policy is likely to boost investor sentiment. This may encourage investors to buy riskier assets, such as shares, thereby driving their prices ever higher.
While the appeal of bonds has increased as their yields have risen, lower valuations across the stock market have made equities more attractive.
Cheaper stock prices, after all, equate to greater scope for capital growth over the long run. Although some income investors may argue that capital returns are irrelevant to them, this column believes that a larger portfolio makes life a lot easier whatever your investment aims.
Although the FTSE 100 index currently offers a sub-4pc income return, it is possible to purchase a wide range of equities with significantly greater yields.
Therefore, a portfolio filled with dividend stocks can generate a far more enticing income return than any index yield initially suggests.
And with numerous stocks having long track records of maintaining, and even growing, dividends in spite of tough operating conditions, equities may prove to be a far more reliable route to income than many fixed income investors realise.
Therefore, while some income investors may currently be intent on purchasing bonds, Questor retains its preference for dividend shares. Although they are far from perfect, their overall income appeal on a long-term view continues to exceed that of bonds.
In fact, it is possible to build a diverse portfolio of high-yielding shares that offers a relatively reliable income which grows at an above-inflation rate over the coming years.
When the low valuations of equities and an improving outlook for the economy amid a more accommodative monetary policy are added to the mix, the total return potential of shares is highly likely to exceed that of bonds.
As a result, equities, rather than fixed income assets, will be the main focus of our income columns in the future.
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