Cash in Hand
REITs and Munis Are Still a Good Deal
Taxes on dividend-paying stocks are lower now, but that's no reason to dump other high-income investments.
By Jeffrey R. Kosnett, Senior Editor, Kiplinger's Personal Finance
May 28, 2003
No question that the new tax cuts make stock dividends a better deal now for investors. By cutting the maximum tax rate to 15%, the government now effectively treats dividends the same as capital gains.
But this column isn't about what the government did. It's about what it didn't do.
Congress and the Bush administration did not do anything to harm other high-income-paying securities, such as municipal bonds and real estate investment trusts.
Don't bail on old reliable now
There is absolutely no reason to sell either type of investment to put the money into dividend-paying stocks. And that's especially true if you depend on portfolio income for living expenses.
Here's why: Municipal bonds are obligated to pay you interest on a regular schedule, and those payments are exempt from federal income tax. Real estate investment trusts (or REITs), which benefit from favorable tax treatment before they count up the profits they distribute as dividends, must pay 90% of net income to stockholders. REIT yields sometimes include a return of capital, on which you don't owe any taxes.
But nothing, and certainly not this tax-cut law, compels corporate America to pay dividends after taxes high enough to compete with bonds and REITs. The new law doesn't include any giant corporate tax breaks that will turn those 1.5% yields into 4% or 5%. Corporations could decide to divert cash from buying back shares to plumping dividends, but that's a wait-and-see proposition.
... or later
As I wrote this, the 11 biggest New York Stock Exchange gainers of the day included exactly zero high-yielding stocks.
The twelfth highest gainer, a British electronics distributor called Premier Farnell (PFP), does yield close to 5%. But foreign companies' dividends are generally ineligible for the U.S. tax break. And even if PFP did qualify, it pays out 28 cents on annual earnings of 30 cents. It would need a big burst of business to raise the dividend. The stock rose 9% to $6.10, but that was because the CEO said conditions aren't as bad as before. Big bloody deal.
On the other hand, REITs were still yielding 6.7%, on average, even after a run-up in share prices. (REITs have delivered a 13% total return so far in 2003.) REITs may be expensive compared with their earnings-growth prospects, but a 6.7% yield is nothing to scoff at, even after you pay taxes on it.
As for municipals, 10-year A-rated bonds are yielding an average of 3.2%, free of federal taxes. And that's what you actually get. Municipal bonds almost never default. And if you're looking for evidence that investors are scrambling to dump municipals as the tax cut comes to fruition, look at the muni market. In the last 30 days, yields on those 10-year A-rated tax-exempts fell from 3.9% to 3.2%, as investors bid up prices. That is one heck of a rally.
REITs and municipals pay reliable, high and steady income. Most stocks do not.