10 Year Treasury VS Dividend Portfolio

Portfolio Management
July 16, 2023

In this article, we compare the discounted cash flow from a 10 year Treasury yielding a 4% return with a dividend-focused equity portfolio and a current yield of 2%. For this comparison, we use a discount rate of 4%, equal to the rate of the 10 year treasury.

The metrics we use for growth rates, tax rates, yields, and discount rates are indicated in the chart. In the future, there will be a link so you can download the worksheet and adjust the values to fit your assumptions.

Over a long period, the S&P 500 has appreciated about 8% per year, that’s made up of approximately 6% earnings growth and a 2% dividend yield. If the P/E multiple remains constant, the S&P 500 index should appreciate in the amount equal to the earnings growth. In this example, we used a more conservative equity growth rate of 5%. As mentioned earlier, you can adjust the metrics based on your outlook. We also use a 4% dividend growth rate. Over long periods, the dividend growth rate typically tracks the earnings growth rate. We were conservative in our dividend growth rate selection.

Let’s examine the pre-tax example first. The discounted value of the cash flow from the 4% 10-year Treasury is $335K, the discounted value of the $1M you will get back in 10 years is $665K. This totals $1M.

As you might expect, since the discount rate is equal to the interest rate, the total value of the interest collected during the 10 year duration of the bond plus the discounted value of the bond at maturity are exactly equal to the initial investment.

Now, compare this with the equity portfolio. Discounted value of the dividends collected over the 10 years is $198K, the discounted value of the stock portfolio at the end of 10 years is $1,082K. The total stock portfolio is $1,281K or 28% more than the bond.

We ignored the impact of inflation on this initial analysis. It shouldn’t be ignored in the final analysis. Inflation will have a much greater negative impact on the 10 year bond than it will on the equity portfolio. Over long periods, the earnings growth of the S&P 500 is similar to the growth in real GDP plus inflation (nominal GDP). According to the St. Louis Fed, nominal GDP has increased about 6.4% annually from 1950 through 2022. If inflation were to be above historical levels over the next 10 years, it would be likely that the stock portfolio earnings growth rate and dividend growth rate would be higher. Nothing would change with the bond portfolio. Your purchasing power on the $1M you’d get back from the bond portfolio would be negatively impacted if inflation was higher, but the number in the chart wouldn’t change.

In the chart below, we look at the returns you can expect in a taxable account. We use top Federal Tax rates which at the time of this writing are 24% for capital gains and dividends and 41% for interest. If you live in NY or CA, your cash flow will be less for the stock portfolio. Interest on Treasuries is not subject to state income tax so your cash flow will be the same.

The 10 Year Treasury Bond will produce $198K in discounted, after tax, cash flow. Add in the discounted value of the $1M you will receive a maturity and the total will be $862K. For the equity portfolio, the discounted, after tax value of all the dividends will be $151K. The discounted value of the equity portfolio will be $1,083K. Assuming you sold the equity portfolio, you’d owe tax on the gain which would be $115K. Your total discounted, after tax, value of the equity portfolio would be $1,083K. That’s a little over 25% more than the bond.