Tax Cuts Help Stocks

August 12, 2003

Falling bond prices and lower tax rates on dividends make many stocks a better buy than securities, says financial writer Scott Burns. There has been a more than 100-basis-point rise in the 10-year Treasury bond yield to 4.5 percent -- yields could rise further; bond prices could fall. (Keep in mind that the yield is the ratio between the price buyers pay for the bond and the fixed rate of interest it earns. Thus if the price of bonds falls, the yield rises -- indicating buyers think interest rates will rise and that they can earn more with other investments.)

  • Interest on Treasury bonds held outside of tax-deferred funds are taxed as ordinary income -- up to 35 percent.
  • Most dividends, on the other hand, are now taxed at 15 percent. The 20 percentage point difference gives dividends a big advantage.
  • The 4.5 percent pretax yield on the 10-year Treasury becomes an after-tax yield of only 2.93 percent.
  • To have the same after-tax yield, a stock needs only a pretax yield of 3.44 percent -- a full percentage point lower.
  • There are 367 domestic stocks (not counting real estate investment trusts) in the Morningstar database with that yield or better, as of June 30.

Since stocks also grow their earnings, says Burns, a portfolio of stocks with high yields starts to look very attractive.

Source: Scott Burns, "Is it time to switch to stock dividends?" Dallas Morning News, August 12, 2003.

 

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