Archives for May 2012

I was following an interesting discussion about living off of dividend income from stocks over at the Bogleheads forum, and member Beagler posted a link to a excerpt on income investing from the book Bogle on Mutual Funds.

You may know that John Bogle is the founder of Vanguard, now one of the largest fund organizations in the world and a pioneer in low-cost index funds. But what I really like about his books is his focus on common sense as the foundation for his advice. An example of this is his Gotrocks parable [pdf] adapted from Buffett. But back to this excerpt. He first points out how stock dividends have been a good way to create an income stream over the long run that grows faster than inflation.

Of course, by investing in common stocks you assume the risk that dividends will decline during periods of recession or depression […] What is truly remarkable is that the record of dividend payments by U.S. corporations heavily favors rising dividends over declining dividends, almost irrespective of prevailing business conditions.

Here’s a chart of the historical S&P 500 annual dividend, inflation-adjusted. (Note this is absolute dividend, not dividend yield percentage.)

Image credit to Multpl.com, data from S&P and Shiller

Now, the problem is that you can also pay too much for dividends. He shares an example of how if you were comparing the dividend income from a diversified stock portfolio yielding 3% and growing at 6% annually or a long-term bond yielding 7% each year, it would take 26 years for the dividend income to total the bond income payments.

Unfortunately, defining what constitutes too high a price for dividends is a fallible exercise, one that must take into account not only the average historical valuations for stocks but the current valuations for other investment alternatives as well. History suggests that stocks are relatively expensive when the price paid for $1 of dividends is above $30 (i.e., a yield of 3.3%) and relatively cheap when the price paid is less than $20 (a yield of 5%). However, stocks may well be attractive at a yield of, say, 3.5% if there are compelling reasons to assume that their dividends will increase rapidly or if yields on other classes of financial assets are relatively unattractive.

In the example shown in Figure 2-5, buying a portfolio of stocks at a 3% yield rather than a bond at a 7% yield might not be a sensible investment, especially considering the incremental risk incurred in holding stocks. When stocks yield 4.5% and bonds yield 6%, that may be quite another story.

What would Bogle say right now, when the S&P 500 yield is ~2% and 30-year Treasury bonds are ~3%? The relative difference between the stock yield and the bond yield is less than 1%. I would argue that his last sentence would suggest stocks are actually preferred over other classes at this point.

Now, I’m not turning in a stock bull, and I still have about 70% stocks and 30% bonds in my portfolio, but this line of thinking makes me happier with my 70% in stocks. I’ve also been looking more at living off of dividend income in “early retirement”.

SmartMoney magazine has released the results of their Annual Broker Survey in its June 2012 issue. Check out the attached article for additional commentary and insight into rankings and methodology. You’ll find my own commentary on their findings below.

SmartMoney 2012 Top 10 Overall

1. Fidelity
2. Scottrade
3. TD Ameritrade
4. E-Trade
5. Schwab
6. TradeKing
7. Zecco
8. Merrill Edge
9. Capital One 360 Sharebuilder
10. WellsTrade

Best in Commission & Fees Category (5 stars)

Scottrade doesn’t have a rock-bottem per-trade commission at $7 a trade, but it’s lower than average and they still win overall due to lower fees elsewhere – such as annual fees, inactivity fees, fees to use a phone, or close out an account.

1. Scottrade
2. Capital One 360 Sharebuilder

Best in Customer Service Category (4 stars+)

One important factor here was speed of reply in addition to accuracy, and per the article all of the brokers surveyed now offer Live Chat online except for WellsTrade. I think TradeKing was the first to offer this feature?

1. TradeKing ($50 opening bonus link)
2. Scottrade
3. E-Trade
4. Zecco

Trends

• Prices are still dropping, although more slowly. SmartMoney reports that in 1994 the average commission price surveyed was $28. Last year, $8.27. This year, only $7.96. Note that every single one of their top 10 brokers have per-trade stock commissions of under $10. I suppose anything higher would just seem greedy now.
• Banking. More firms are adding banking features like debit cards and billpay to make it more likely that you’ll keep all your money there, joining firms like Merrill Lynch (Bank of America) and WellsTrade (Wells Fargo) which are already closely aligned and owned by big banks.
• Smartphone and iPad apps. These are indeed cool, but the brokers really love them because they increase your trade activity.

Omissions

SmartMoney mentions the the Merrill Edge BofA deal, where you can get 30 free trades a month if you hold a combined $25,000 as cash in your *deposit* accounts only at Bank of America. However, they don’t mention the WellsTrade deal which offers 100 free trades a year if you hold a combined $25k across acounts including your brokerage balance, but instead requires a PMA checking account that you have to keep active with “in-person” activity like writing a physical check at least once a year.

WellsTrade and Zecco enter the top 10 this year, but Vanguard and OptionsXpress were bumped out. Vanguard was #7 in their 2011 rankings. There was no mention of what happened… I’d like to know if they were notably worse in some area or were simply excluded? OptionsXpress was bought by Schwab last year, but still runs an independent site.

Finally, there was no mention of the quantity and quality of the commission-free ETF lists offered by the majority of these brokers. If anything, I thought that was more important to mention than smartphone apps that scan product barcodes at the grocery store.

Finding The Best Broker For You

Don’t forget to compare these results with the Consumer Reports 2012 Rankings and the Barron’s 2012 Rankings. The key is to drill down to see which broker satisfies your personal set of needs the best, as there is a lot of fluff in there. This is why I’d rather look at specific sub-rankings more closely than the big headline “Top 10” rankings.

Take the “Banking” category, which included as a criteria but some brokers just don’t offer banking services and I don’t think they should be penalized for it. Another area I don’t care about is “Research” tools. I’ve ever used a broker for research. Morningstar offers me everything that I need, otherwise I just look at Google/Yahoo quotes and look for related news and blog articles. I don’t see how a discount broker would have the time or resources for unique analysis. Just give me cheap trades with good fills, solid customer service when I need it, and track my capital gains and tax lots accurately.