If income is your investment objective, the deck is stacked against you, as interest rates remain velcroed to record lows. But there are attractive dividend stocks out there, provided you can commit for the long run.
Investors seeking current income, who traditionally rely on tax-free municipal bonds or quality corporate bonds, have been forced to take on more risk over the past two decades. Bond yields had sunk even before the bursting of the real estate bubble in 2008, which led to the Federal Reserve pushing the benchmark federal funds rate to its current range of zero to 0.25%.
Low bond yields made preferred stocks, which feature a fixed dividend rate, much more attractive. But high-yielding preferred stocks have also become difficult to come by, as companies have called (or bought back) issues with higher yields, taking advantage of low interest rates and a high level of liquidity to lower their cost of capital.
Another painful trend for investors looking to buy newly issued preferred stocks “off the shelf” from their brokers, thus avoiding commissions, is that many have par values of $100,000. Those and other new preferred issues with lower par values are quickly snapped up by institutional investors.
A major worry for many yield-hungry investors is that when the Federal Reserve begins raising the federal funds rate, market prices for any yield-producing investment can come under pressure. When interest rates rise, the value of an existing bond or preferred stock must adjust itself lower so it has the same yield as a similarly rated new security.
So if you are looking for income, you had better be ready for a long-term commitment. Some investors have been willing to take on more risk by buying dividend stocks. Real estate investment trusts have been popular and lucrative in recent years, with interest rates so low for so long. Business-development companies are another attractive alternative, provided you can ride out high volatility if, and when, another recession emerges. BDCs tend to feature very high dividend yields.
The importance of rising dividends
Purchasing common stocks with high dividend yields may be your easiest way to “buy income” in this market, and if you make the right picks and stick with them through the inevitable short-term fluctuations, you may find yourself outperforming the overall market on a total-return basis.
One example of this is the S&P 500 Dividend Aristocrats, which is a list of over 50 stocks maintained by S&P Capital IQ. The Aristocrats have all raised their dividends annually for at least the past 25 years, and the group has also greatly outperformed the S&P 500 Index SPX, -0.46% over long periods:
Here’s how the Dividend Aristocrats and the S&P 500 compare, on a total return basis, with dividends reinvested:
|Total return – 3 years
|Total return – 5 years
|Total return – 10 years
|S&P 500 Dividend Aristocrats
|S&P 500 Index
As you can see, the longer the period of comparison, the better the relative performance of the Dividend Aristocrats. There are ETFs that track the Dividend Aristocrats. One example is the ProShares S&P 500 Dividend Aristocrats ETFNOBL, -0.78%
But the Dividend Aristocrats as a group are really a long-term growth, rather than income, play, because many of the stocks in the group feature relatively low dividend yields. The determining factor in their inclusion in the list is the consistency of dividend increases.
[“source – marketwatch.com”]