High-Yield Dividend Stocks:

By Don Schreiber, Jr.

Seeking protection from increasingly volatile markets, investors have yanked a page out of legendary value investor Benjamin Graham’s tome, The Intelligent Investor, and are persistently seeking investment strategies that provide them with a safety edge.

The rules to investing are undergoing a dramatic change as investors revolt against failed strategies and become more aware of recent evidence that shows dividend-paying stocks, not growth stocks, should become the foundation on which portfolios are built.

When the government lowered the tax on capital gains for the first time in 1981, a new tax-driven preference for owning growth stocks caused many investors to forget about dividends and the benefits that they provide. In a rush to pay lower taxes, safe and consistent quarterly dividend (a component of return) was abandoned in favor of pure price appreciation, the only component of growth stocks. Regretfully, prices fell fast and hard, as the remarkable bull market of the 80’s and 90’s became a distant memory.

Back in the Spotlight
The good news for advisors is that dividend-paying stocks are back in the spotlight. In 2003, the government passed new tax legislation removing the arbitrary tax preference for returns generated by capital gains and provided tax relief to returns from dividends. This prompted many investors to revert to increasing their allocations to dividend- paying strategies.

One of the big selling points for dividend paying stocks is that they are often a safe harbor during uncertain times. Not only can investors count on steady and reliable return from dividends, but dividend payers tend to be less volatile. This is a major appeal as not too many investors can tolerate huge market drops or extended periods of volatility. Look at the 2000-2002 bear market cycle. The dividend-focused Dow Jones Industrial Average Index fell 26%, while the growth stock oriented NASDAQ Composite Index fell 67%.

Debunking a widely held belief
The old idea that dividend stocks provide less return than growth stocks is being discarded as new research is being published. One of Wall Street’s leading research firms, Ned Davis Research, Inc., released a study last year that debunks this widely-held belief. By analyzing the returns of S&P 500 stocks by dividend policy, the study shows that dividend paying stocks have outperformed non-dividend paying stocks dramatically.

Although stock prices tend to fluctuate more wildly, dividend returns tend to be more consistent, providing returns more silently but surely over time. As such, it’s not a surprise that during bearish markets, dividend stocks outperform their non-dividend-paying counterparts.

A viable strategy for financial advisors is to shore up their clients’ portfolios with high-yielding dividend paying stocks, given the fact that traditionally high-yielding dividend stocks are not only less volatile, but offer investors a more reliable return opportunity. Many market pundits are forecasting modest price appreciation of 5-6% from stocks over the next decade, so why not match appreciation with a 3-5% dividend yield to generate the 10% historical rate of return that most investors want?

Avoiding Capital Depletion
As a large percentage of our population gets closer to retirement, the risk tolerance of this group for any loss of investment capital declines significantly. Consequently, their focus is shifting to capital preservation, as every penny will be needed to generate income while in retirement. To effectively address the specific income and inflation protection needs of retirees, financial advisors should create for these individuals balanced portfolios that employ a mix of bonds and high-yielding dividend paying stocks to lower overall risk.

While bonds don’t generally keep pace with inflation, the higher income they generate, combined with high yielding stocks, produces an attractive level of income and inflation protection. Companies that pay dividends tend to increase dividends over time and stock appreciation can be used to further increase income in an effort to fight inflation.

Dollar ‘Lost’ Averaging
Strategies based on systematic withdrawals from growth stocks or growth portfolios to generate income have miserably failed investors. In reality, share prices fluctuate widely causing investors to sell more shares when prices are low, thereby accelerating capital liquidation. Especially during prolonged market declines, such strategies can generate significant capital depletion and impair retirees’ ability to generate income. Market volatility turns systematic withdrawal plans into the evil twin of dollar-cost averaging, which I like to call “dollar lost averaging”. In its mildest form dollar lost averaging increases the risk of outliving capital. As the flaws of this widely promoted strategy become more commonly known, advisors and brokerage firms are finding the compliance risks associated with this strategy to be a significant problem.

Today’s investors are ready to embrace dividend-based investment programs that will keep them comfortably invested while achieving the returns they need to accomplish their growth and income goals.

FA