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Dividend Stocks Instead of Bonds

NEW YORK ( TheStreet) -- Frustrated with low bond yields, investors have been pouring into ETFs that focus on dividend-paying stocks. During the past year, Vanguard High Yield Dividend (VYM) recorded inflows of $2.6 billion, while iShares High Dividend Equity (HDV) attracted $975 million, according to IndexUniverse.com.

The rush into dividend stocks has left many financial advisors shaking their heads. According to the conventional view, all stocks are risky, including dividend stocks. Advisors warn that in the next downturn, dividend stocks could sink along with the rest of the market. For protection, investors should hold sizable stakes of government and high-quality bonds.

Noted Princeton professor Burton Malkiel takes a different view. Malkiel is urging clients to shift from government bonds into dividend stocks and other assets. "The old saw is that government bonds are the safest investment in the world," he says. "But these days government bonds are risky."

Malkiel recently became chief investment officer of Wealthfront, an advisory firm that designs low-cost ETF portfolios for clients who have a minimum of $5,000 to invest. The firm recently changed its portfolios, eliminating government bonds and increasing the allocation to dividend-paying blue chips.

Malkiel is best known as an early proponent of index fund investing. In his 1973 bestseller, A Random Walk Down Wall Street, he argued that active fund managers had little chance of outdoing the market averages. Instead, he has urged institutions and retail investors to use index funds.

A former board member of Vanguard Group, Malkiel has often championed the company's low-cost stock and bond index funds. But these days he is cautioning investors about the use of Vanguard Total Bond Market (BND), a popular index ETF with $18 billion in assets. "The ETF has two thirds of its assets in government and agency bonds," he says. "That's a lousy investment now."

Malkiel argues that in the next decade, bonds are likely to return nothing. The problem is that interest rates are bound to rise. When that happens, bond prices tend to sink. The coming bond bear market may not start this year or next, Malkiel says. For the time being, the Federal Reserve is holding down interest rates. But when the Fed begins loosening, rates will climb.
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