A Different Way to Look at Dividend Paying Stocks

Wall Street is full of worn-out phrases.  One of them is “dividend-paying” stocks.  Yes, some stocks pay dividends and others do not.  But it seems as if fund companies and money managers think that dividend-paying stocks is what investors want in retirement and approaching retirement.  These Wall Streeters are falling short of what the real goal is: sufficient income to fund one’s lifestyle in retirement.  Let’s face it, buying 10-year U.S. Treasuries is not going to get it done.  And high-yield bonds can be fraught with credit risk.

Dividends from stocks can be a very helpful in this situation.  After all, they are predictable, the payouts often increase as the company raises its dividend rate, and it is the future success of the underlying business, not specifically the creditworthiness of a single bond issue, that determines the continuation of that investment cash flow.

Furthermore, if a retirement-minded investor focuses on that dividend income, the inherent fluctuations of the stock market are less annoying.  Even if your stock prices bobbed and weaved for five years, only to break even, you would still earn your dividend.  And if you play it right, that dividend yield can be well in excess of what high-quality bonds pay now.  As an additional perk, if you believe as I do that a great complement to a dividend portfolio is a hedging mechanism to stem the impact of major market meltdowns, the reward/risk tradeoff can be even better.

But none of this matters if your “dividend-paying stocks” yield 2%.  And the fact is, most dividend mutual funds and ETFs pay puny yields versus that investor’s true benchmark: what they need to withdraw annually to pay for all of the stuff in their life while retired.

The Universe of Dividend Paying Stocks

I am not going to help you solve this problem in one article.  But what I can do is tell you about a structure we use at our firm which may help.  We look at the universe of dividend-paying stocks and divide it into five separate dividend ranges.  Here they are, with brief explanations:

  1. Dividend-Paying Stocks: Pays a dividend, but not enough to retire on for most people.
  2. White Chips (High-Quality “Blue Chip” Stocks with Modest Yield: Get what you pay for. Dividends are there, but are insufficient to fund many retirements.
  3. “Sweet Spot” Dividend Stocks: Sweet Spot means the yield is greater than White Chips, but not so high that we consider the dividend a risk. Stable or growing dividend amount. Healthy Payout ratio. Reasonable level of stock price volatility (typically below that of the S&P 500’s volatility). Measured by Beta.
  4. High-Yield Stocks: Yield way above S&P 500 yield. Okay to have some in the portfolio if well-researched, but not an entire portfolio of them. Implies some speculative element of owing it, since there is no “free lunch” in investing.
  5. Extreme Yield Securities: Way, way above S&P 500 yield. Typically have some element of leverage (e.g. closed-end funds, companies with severe debts levels, etc.). Often pay out this high yield for longer than many think. Then one day, BAM! You are left with losses beyond what you took in via dividends.

Dividend Stocks

By dividing the dividend stock universe in this way, you can focus on the level of yield needed, and balance that against the risk you are taking by reaching for yield.  Personally, I spend the majority of my time in the “Sweet Spot” category.  In today’s market environment, that leads me to companies that yield in the 3.5%-5.5% range, and building a portfolio dominated by good businesses with that yield level allows us to generate the level of yield many of our investors require.  But the White Chip and High Yield tiers get plenty of our attention too, just less so than the Sweet Spots.

I think that more investors should be taking a dividend tiers approach to constructing income and growth stock portfolios.  Your tiers and definitions of those tiers may differ from mine, but at least you will go beyond this silly “dividend-paying stocks” sales pitch Wall Street firms use to lure their clients into portfolios that sound good out loud, but then deliver inferior yields to the investor.

Are you properly gauging how much investment risk to take? How do you survive a bear market for stocks or bonds? How can you properly assess the tradeoffs between passive and active investing? What is hedged investing and how can it potentially aid in your retirement investing approach? For research and insight on these issues and more, click HERE.

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This material was compiled by Sungarden® Investment Research. Sungarden Investment Research provides advisory services through Dynamic Wealth Advisors. This material has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Past performance is not a guarantee or a reliable indicator of future results. Investing in the markets is subject to certain risks including market, interest rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. SungardenInvestment.com does not provide personal investment advice. 

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