With rising interest rates, does it still make sense to invest in dividend stocks? In this episode, I compare a dividend stock to a money market fund, which one is the better investment?
I also cover the following topics in this episode:
- Rising interest rates
- What are money market funds
- Typical money market returns
- What will happen to interest rates?
- Money market fund versus a dividend stock
- $10K grows to over $12K in 3 years
Disclaimer: The views and opinions shared on this channel are for informational and educational purposes only. Simply Investing Incorporated nor the author and guests shall be liable for any loss of profit or any commercial damages, including but not limited to incidental, special, consequential, or other damages. Investors should confirm any data before making stock buy/sell decisions. Our staff and editor may hold at any given time securities mentioned in this video/course/report/presentation/platform. The final decision to buy or sell any stock is yours; please do your own due diligence. Stock buy or sell decisions are based on many factors including your own risk tolerance. When in doubt please consult a professional advisor. No advice on the buying and selling of specific securities is provided. All trademarks, trade names, or logos mentioned or used are the property of their respective owners. For our full legal disclaimer, please visit our website.
With rising interest rates, does it still make sense to invest in dividend stocks? In this episode, I compare a dividend stock to a money market fund, which one is the better investment?
I also cover the following topics in this episode:
- Rising interest rates
- What are money market funds
- Typical money market returns
- What will happen to interest rates?
- Money market fund versus a dividend stock
- $10K grows to over $12K in 3 years
Disclaimer: The views and opinions shared on this channel are for informational and educational purposes only. Simply Investing Incorporated nor the author and guests shall be liable for any loss of profit or any commercial damages, including but not limited to incidental, special, consequential, or other damages. Investors should confirm any data before making stock buy/sell decisions. Our staff and editor may hold at any given time securities mentioned in this video/course/report/presentation/platform. The final decision to buy or sell any stock is yours; please do your own due diligence. Stock buy or sell decisions are based on many factors including your own risk tolerance. When in doubt please consult a professional advisor. No advice on the buying and selling of specific securities is provided. All trademarks, trade names, or logos mentioned or used are the property of their respective owners. For our full legal disclaimer, please visit our website.
With rising interest rates, does it still make sense to invest in dividend stocks? Is a money market fund returning more than 5% better than a dividend stock yielding only 3%? I'm going to answer these questions in today's episode. Hi, my name is Kanwal Sarai and welcome to the Simply Investing Dividend Podcast. In today's episode, we're going to cover the following four topics First, we'll talk about the rising interest rates in today's current economic environment. Then we'll talk about what are money market funds, then we'll look at some examples of money market funds and their returns and then we will compare a typical money market fund with a typical dividend stock and find out which is the better investment. Let's get started with our first topic rising interest rates and the biggest question most people have, and they've seen in the last 12 to 18 months that interest rates have gone up and they may continue to go up. They may not, but let's take a look. So the question is have interest rates gone up? And the short answer is yes. Let's take a look at the US fund rate in the last three years and you can see the graph on the screen and you can clearly see that the rates have gone up consistently, beginning at around February, march or middle of the year in 2022. Nevertheless, it was in 2022 where the US Federal Reserve had started to increase the interest rates, and you can see on the graph prior to 2022, they were close to, very close to 0%, and then we can see that the year 2022 finished off at around one and a half 2%. The year 2022 finished off at around one and a half two percent. Then the rates went up to three percent, four percent and currently sitting at five point three, three percent as of this recording. And the situation is similar in Canada. If we look at the Bank of Canada, the interest rates in the last three years again you can see on the screen the interest rates have gone up. And same thing prior to 2022, they were sitting at almost 0% for many, many years and the interest rates have gone up since then. And now, as of this recording, they are sitting at 5.25%, which is all good news for term deposits, cds or, in Canada, gics and money market funds, because all of those types of investments have increased the interest rates that they are offering to investors.
Speaker 1:So now let's move on to our second topic of what are money market funds? And, quite simply, a money market fund is a type of mutual fund that invests in high quality short term debt instruments and cash and cash equivalents. If you look at some of the instruments, it's primarily US Treasuries or T-bills or Treasury bills, and so that's what's inside of a money market fund. Now there's some pros and cons to money market funds. So some of the pros are obviously it's very low risk, highly liquid, easy to cash it in and they generally offer better returns than you'll find in a bank account. Now some of the cons they are not FDIC insured, there's no capital appreciation, the net asset value of the mutual fund or the unit price is always fixed and they are certainly sensitive to interest rate fluctuations and changes in monetary policy. So if rates continue to go up, then you'll find that the money market funds will continue to offer higher interest rates. However, if interest rates start to come down, then the money market returns will also start to come down.
Speaker 1:Now let's take a look at some of the returns. That's our third topic here. Let's see in the short term, as of this recording, what are some of the money market returns and you can see up on the screen here. I've taken four typical examples of some money market funds. Now the numbers are high, but we are only looking at the seven day yield, not the one year yield or the three year or five year. We're just looking at the seven day yield. So, just as an example you can see on the screen here, fidelity money market fund has a seven day yield of 5.04%, the T-Row US Treasury money market fund is at 5.4%, the Vanguard money market fund is at 5.27% and the Fidelity government money market fund is sitting at 4.98%.
Speaker 1:Now, let's not forget, each of these funds have an annual expense ratio. Now, I know some of the brokers say that there's no fee to buy them. That's absolutely true. They may offer no fees to buy mutual funds or index funds or ETFs, but these funds themselves have an annual expense ratio. This fee is deducted automatically from your investment in any of these funds, investment in any of these funds. We'll talk a little bit more about the expense ratio later on. Just as an example, the Fidelity Money Market Fund has an expense ratio of 0.42%, the TRO is at 0.3%, vanguard is at 0.11% and the Fidelity Government Money Market Fund is also at 0.42%.
Speaker 1:Okay, so now let's get on to our main topic in this episode, and what we want to do here is we want to compare a typical money market fund to a typical dividend stock and then figure out which investment is better, which one is going to offer a higher return. So I'm going to show you the same slide we looked at before, which was the four examples of money market funds up on the screen, the seven-day yield, and let's just take an average of the seven-day yield and you can see it's at 5.17%. Now, remember, this is not a one-year yield or a two or three-year yield, it's a seven-day yield and you can see it's at 5.17%. Now, remember this is not a one-year yield or a two or three-year yield, it's a seven-day yield, but still the number is quite high. Let's compare that to four typical dividend stocks and what we're going to look at is the dividend yield. So Johnson Johnson has a current dividend yield, as of this recording, of 3.08%, coca-cola is at 3.21%, walmart is at 1.37% and McDonald's is at 2.4%. Now if you take the average here, you'll notice that it is not as high as the money market funds. The average dividend yield for these four dividend stocks is 2.52%. Now, if we compare both of the averages again, what we're highlighting here is that the money market funds, the seven-day yield is typically, as of this recording, higher than most dividend stocks, so it's at 5.17% versus 2.52%.
Speaker 1:Now, the goal of this topic in this episode, is to compare a typical money market fund to a typical dividend stock. So to do that, we need to cover four things. Number one we need to decide, okay, what are we going to compare with. So, which money market are we going to select? Which dividend stock are we going to select? Number two what is the amount that we're going to invest in? Number three what is the time horizon? And number four what is the rate of return? So we're going to go through all four of these, but let's start with number one on the list. So, for the purposes of this episode and just to keep it simple I know there's hundreds of money market funds to choose from. There's thousands of dividend stocks to choose from. We're going to try and keep this simple and short. For this example, I'm going to select the Fidelity Money Market Fund. If anybody's interested, you can look up the details. The fund symbol is SPRXX and we're going to compare it to Johnson Johnson, which is a dividend stock.
Speaker 1:Just a quick little summary of Fidelity Money Market Fund. The fund was started in 1989. It has a unit value, an NAV, of $1, right? So the price is fixed at $1 and the expense ratio, as we showed before, is at 0.42%. If we take a quick look at Johnson Johnson for 2%. If we take a quick look at Johnson Johnson, it's a US company. It was founded in 1886. The share price as of today, as of this recording, is $154.76 to buy one share. The dividend yield is 3.08% and the company has had an incredible track record of consecutive years of dividend increases at 62 years. So the company has been consecutively increasing its dividend to the shareholders every single year for 62 years. So that's something very important to note.
Speaker 1:Now let's go back to our four things that we needed here. So, number one we know which investments we're comparing with. So the Fidelity Money Market Fund and we're going to compare it with the Johnson Johnson stock. Number two what is the amount invested? So, for this example, we're going to go with $10,000 each. So imagine you had $10,000, you could invest it in Fidelity, or you could invest the same $10,000 in Johnson Johnson. So that's the amount invested. We're going to keep it the same for both investments.
Speaker 1:The time horizon for now, we're going to keep it at three years Now. For those of you who've listened to all of our episodes, you know that we are long-term investors, long-term dividend investors. So when we think in terms of investing, our time horizon is typically 10 years, 15 years, 20, 25, 30 years like very, very long term. But for now, in this video, I'm going to keep it at 3%. We just want to keep it simple and you'll see why in a couple of minutes, why we want to leave it at three years. But that's the time horizon we're going to use in today's comparison.
Speaker 1:Next is the rate of return. So what is the rate of return we're going to use for Fidelity and what are we going to use for Johnson Johnson? Now to answer that question, we need to figure out well what's going to happen to the interest rates in the next three years, even this year. A lot of people are curious as to what is going to happen to interest rates. Like I said at the beginning of this episode, if interest rates continue to go up, that's going to mean that the money market funds are going to be able to provide higher returns. If the interest rates come down, then the returns on those money market funds will come down as well. So what is going to happen to interest rates In the short term? In the long term, what is going to happen?
Speaker 1:So for this, a couple of headlines. I did some research. Most recently, on March 20th, usa Today reported and this is an actual headline, you can see up on the screen here. It says the Federal Reserve March meeting rates hold steady Three cuts seen in 24 this year, despite inflation, this year, despite inflation. Another headline from the Associated Press on the same day, march 20th. Their headline reads Federal Reserve still foresees three interest rate cuts this year, despite bump in inflation. And one more headline from Reuters, march 21st of this year, march 21st of this year Feds see three rate cuts in 2024, but a more shallow easing path.
Speaker 1:So what's the common theme here? The common theme is that everyone seems to be expecting at least three interest rate cuts in the US this year, in 2024. So if that happens, well then the money market funds are going to have lower returns, but that's fine. The biggest unknown here is we don't know when the cuts will happen and we don't know how much they will be cutting. But that is the expectation in the market today. So what are we going to use for the rate of return. We still need to put a number into our calculator to figure out what the total returns are going to be.
Speaker 1:So what I did is I took a look at the Fidelity money market fund and I looked up the average annual returns for one year, for three years, five years and 10 years. So you can see the one year return is pretty good. It's 5.02%. So that would be last year to 2023. The three year return is 2.38%, five years is 1.83% and the 10 year return for this fund has been 1.25%. So then I did the same thing with Johnson Johnson and you can see the numbers up on the screen. So Johnson Johnson, the one-year return was not that great. It was negative 8.61%. The three-year return was 8.07%, five-year return was 37.78% and the 10-year return was 111.30%. So just looking at these numbers alone, you can see that over the last 10 years, johnson Johnson has done incredibly well against the Fidelity Money Market Fund. After five years, same thing the return is much higher Over 37% return versus 1.83% return. Over five years, johnson Johnson versus Fidelity the three-year return also Johnson Johnson does really well. In the one-year return, the mutual fund does better the Fidelity Money Market Fund.
Speaker 1:So theoretically I don't recommend this, but theoretically you could invest in the Fidelity Money Market Fund just for a year and then pull your money out. But here's the thing we just talked about three interest rate cuts are expected this year. So this requires a lot of timing. A lot of you got to watch the interest rates and watch when the announcements happen, and sometimes you'll see that the money market funds, the rates, will fluctuate even before the interest rates are announced. Maybe I'm not sure, but what you need to do then is any money that you put in the money market fund you're going to have to watch it. You may have to pull the money out before 12 months because of the interest rate cuts that are expected. So it's a little trickier and more complex.
Speaker 1:If you're going to invest in a money market fund for the very, very short term right, we're talking less than a year, because that's the only time where you can see that it outperforms our dividend stock, johnson, johnson. Now, in reality, we're not just putting all of our money in one money market fund and we're not putting all of our money into one single dividend stock, right, in both cases you should diversify so you may own different funds, you may own different stocks. So the one-year return maybe the stocks do better than the money market funds, or vice versa, we don't know for sure. You'd have to look up all the numbers. So, to keep today's episode simple, I'm going to just use the three year time frame. That's our time horizon. Ok, we're going to stick with three years horizon. Okay, we're going to stick with three years.
Speaker 1:Let's see how the money market performs against the dividend stock Johnson Johnson. So now we have all the data we need. We have the two investments. We've got our money market fund, we've got Johnson Johnson. Our amount invested is going to be $10,000 each. The time horizon we're going to stick with three years. The rate of return so we're going to use the average rate of return for Fidelity, which was 2.38%. We're going to use the average rate of return over the last three years for Johnson Johnson, which was 8.07%.
Speaker 1:Now let's not forget the expense ratio. The Money Market Fund has an expense ratio of 0.42%. Johnson Johnson is a dividend stock. There is no expense ratio. Some of the brokers are now offering zero commissions, so you could buy Johnson Johnson with zero commission. If not, then just deduct $5 or $8, whatever the commission is from the total value that I'm going to show you right now. Okay, so the ending value after three years Fidelity Money Market Fund, once we've subtracted the expense ratio, will be worth $10,599.60. Johnson Johnson over the same period, will be worth over $12,621. So that is a difference of 19.08%. So Johnson and Johnson clearly is the winner here. It's worth more. The investment in Johnson and Johnson over three years is worth more than what you would have received with the Fidelity Money Market Fund.
Speaker 1:Now, keep in mind Johnson and Johnson has a current dividend, as of this recording, of four dollars and4.76 a share, the dividend yield based on the purchase price if we go back three years. So had somebody bought Johnson Johnson, had you bought the stock three years ago, your current dividend yield today based on the purchase price would be over 3%. If you went back five years and you purchased Johnson Johnson five years ago, on January 1st five years ago, your dividend yield based on the purchase price would be over 3.69%. And if we go back 10 years and you had bought Johnson Johnson 10 years ago, not only would you have collected dividends over those 10 years, your current dividend yield based on the purchase price would be over 5.2%. So now you're making more money annually than a typical money market fund.
Speaker 1:So there's an advantage to buying the dividend stocks and then holding onto them, because you take advantage of the increasing dividends coming to you every single year and if you take those dividends and reinvest them into other dividend paying stocks, you can compound your growth even faster, and you can do this without selling a single share of your initial investment. So that's the advantage. And the other advantage we haven't talked about is capital appreciation is, as the stock price goes up, every time a company increases its dividend over the long term, the share price generally comes up, and that also provides you with higher returns, and you don't have that capital appreciation with a money market fund. So, having said all of this, I still think I believe that in this example, johnson Johnson is still clearly the winner. Johnson is still clearly the winner.
Speaker 1:Now, like I said, the money market fund perhaps it does better in. You know, if we looked at the last 12 months did better than Johnson Johnson. But going forward, taking into account the potential interest rate cuts, taking into account dividend growth, dividend increases and looking at the historical data the last three years, five years and 10 years you can see that Johnson Johnson should outperform the money market funds. So does this mean that you should go out and buy any stock that pays a dividend, just like Johnson Johnson? And the short answer is no. There's a couple of more things we need to check here.
Speaker 1:Our approach to investing is to invest in quality, dividend-paying stocks when they are priced low, so not just at any price. They have to be undervalued, and not just any stock. It has to be a quality, dividend-paying stock. So how do you know, when you're looking at a stock, that it's a quality stock? How do you know it's price low? For that I've created what I call the 12 rules of Simply Investing.
Speaker 1:This is your checklist. You have to make sure that a stock passes all of the 12 rules before you invest in it. If there's one failure, skip it, move on to something else. You can see the 12 rules up on the screen here. Rule number one do you understand how the company is making money? If not, skip it, move on to something else. Rule number two 20 years from now, will people still need us product and services? Rule number three does the company have a low-cost competitive advantage? Rule number four is the company recession-proof? Rule number five is it profitable? Rule number four is the company recession proof? Rule number five is it profitable? Rule number six does it grow its dividend? Rule number seven can it afford to pay the dividend? Rule number eight is the debt less than 70%? Rule number nine avoid any company with a recent dividend cut. Rule number 10, does it buy back its own shares? Rule number 11, is the stock price low? Rule number 12, keep your emotions out of investing.
Speaker 1:So, for those of you that are interested, I've created the self-paced online Simply Investing course. The course is divided into 10 modules. Module 1 covers the investing basics. Module 2 covers the 12 rules of Simply Investing. Module 3, I show you how to apply the 12 rules using a Google Sheet. Module four I show you how to use the Simply Investing platform. Module five placing your first stock order. Module six building and tracking your portfolio. Module seven knowing when to sell, which is just as important as knowing when to buy. Module eight reduce your fees and risk. Module nine your action plan for getting started right away. And module 10, I answer your most frequently asked questions.
Speaker 1:I also have created the Simply Investing platform that applies these rules to over 6,000 companies in the US and in Canada every single day. So the platform is a really quick way to filter out and look at which companies you should consider for investing and which ones you should avoid. If you're interested in the course or the platform, write down the coupon code SAVE10. S-a-v-e-1-0. This coupon code is going to give you 10% off of the course and the platform as well. If you enjoyed today's episode, be sure to hit the subscribe button. We have a new episode out every week. Hit the like button as well, and for more information, take a look at our website, simplyinvestingcom. Thanks for watching.