Despite all of the volatility and uncertainty of stocks, baby boomers heading into retirement are still better off with stocks than bonds, says a new analysis from Bank of America Merrill Lynch.
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Retired couple
One persistent overhang in the markets is that the swell of boomers—those born between the end of World War II and 1965—will start selling stocks as they retire and put their investments in fixed-income.
This so-called "market meltdown" is unlikely, BofA/ML chief equity strategist David Bianco and his team say in their analysis, based on a belief that these investors will be hunting for yield and will do better with dividend-paying stocks than bonds.
"We anticipate that real long-term risk-free interest rates will stay below their normal historical range of 2-3% for several more years, owing to elevated household savings rates and depressed household borrowing," the firm said in research for clients.
"Given the elevated EPS (earnings per share) yields of stocks at a time of historically low real interest rates (actually negative after tax), the opportunity cost of holding cash instead of stocks could be very high over the next several years," BofAML added.
The analysis assumes that nonfinancial companies in the Standard & Poor's 500 will begin putting to work the $1.2 trillion in cash they've stashed away over the past few years—in the form of dividends to shareholders as well as capital expenditures, mergers and acquisitions and share buybacks.
The result will be an overall dividend increase of 25 percent in each of the next two years and presumably a solid pace afterwards. The analysis models dividend-paying high-quality stocks under this formula against expected bond performance over the next seven years.
Even with a 10-year Treasury yield of 4.5 percent—nearly 50 percent above current levels—the analysis finds that S&P 500 top dividend-yield stocks would return 40 percent better than bonds.
There is a critical caveat, though.
"Many of the highest dividend-yielding stocks have low earnings growth potential and little room to raise their payout ratios," the BofAML team wrote. "This is why we recommend that investors focus on stocks with solid earnings growth outlooks and room to raise payouts."
The 25 stocks that the firm says will work well with its dividend model are:
