Dividend Stocks Vs. Long-Term Bonds: Comparing Risk-Adjusted Returns

The goal of any investor should be either:

Incorporating both returns and risk into an investment strategy can be tricky. Performance is easy to measure, but risk can be more difficult to quantify.

After all, how do we define risk? Is it the probability of losing money (which itself is hard to estimate), or something else?

The investment community has generally accepted volatility as the best proxy for investment risk. Volatility is a stock’s tendency to ‘bounce around’. Low volatility dividend stocks will produce consistent returns, while high volatility stocks tend to be more unpredictable.

Fortunately for dividend investors, dividend stocks have great risk-adjusted returns when compared to even the safest asset class – government bonds.

Click here to download an Excel Document that compares the risk-adjusted performance of dividend stocks to long-term government bonds.

Conservative investors can juice a bit more yield out of government bonds by venturing further out on the yield curve and investing solely in 20- or 30-year government bonds, which collectively are called ‘long-term’ government bonds.

With the added returns from investing in longer-term bonds, many would assume that long-term government bonds and dividend stocks would have a similar risk/reward profile.

This article will compare the risk-adjusted returns of dividend stocks and long-term bonds in detail. The article will conclude by detailing a few actionable ways that investors can improve the risk-adjusted returns of their portfolio.

Measuring Risk-Adjusted Returns

The most common metric to measure risk-adjusted returns is the Sharpe Ratio.

The Sharpe Ratio measures how much additional return is generated for each unit of risk. It is calculated as:

One of the tricky elements about performing a Sharpe Ratio analysis is determining what to use for the risk-free rate of return. When analyzing stocks, the 10-year U.S. government bond yield is often used, as the probability of a default from the U.S. government is generally assumed to be zero.