The Alternative to Low-Interest Saving: How to Invest in Dividend Stocks

The Alternative to Low-Interest Saving: How to Invest in Dividend StocksBob is a 70-year-old retired hospital administrator who has spent the last decade volunteering in West Africa with his wife, a nurse, to help improve the hospital systems there. (He asked his full name not be used.) Now back home in California, the Vietnam veteran and father of two is worried about the nest egg he built over four decades.

"I have too much money in a money market account, and it's hard to watch its purchasing power decline as inflation eats up the paltry earnings," Bob says.

Bob's dilemma is one that's shared by millions of retirees. With interest rates at historic lows, there are far fewer options for drawing a steady income stream from your nest egg. Just over a decade ago, someone who had $1 million saved for retirement could park it in simple CDs and get more than 5% interest, providing an annual income above $50,000. Today, the same investment strategy would yield about 0.3% -- or an income of $3,000.

That's why Bob and many other retirees are looking more closely at stocks that pay dividends -- a portion of the company's earnings -- to shareholders, typically each quarter. Dividends are usually quoted in the dollar amount per share. An investor who owns 10,000 shares of a company with a dividend of 8 cents a share will receive $800 over the course of the year. But simply choosing a handful of the highest-yielding shares is not the best approach, experts say.

'High Yield Isn't Necessarily Safe Yield'

"Prior to the financial crisis, the dividend yields on a lot of bank stocks and other financial stocks were quite attractive before they cratered," says Cal Brown, a Virginia financial planner. "You can't just go by the dividend yield thinking it will protect you on the downside." Dividend yield refers to the dividend as a percentage of the current stock price. Back in December 2007, the dividend yield of IndyMac Bancorp was 11.8%. It filed for bankruptcy eight months later.

"High yield isn't necessarily safe yield," agrees Farrell. "You really have to think about owning a collection of operating companies diversified across industry sectors to protect yourself against a couple that may flame out." Farrell's firm, Northstar Investment Advisors, has developed its own dividend-focused index, with returns certified by S&P, that it uses to model client portfolios.

The ideal is to own a broad mix of blue-chip companies that produce meaningful income -- but also grow that income. For example, Standard & Poor's assembles an annual list it calls the "Dividend Aristocrats" -- companies that have paid and increased their dividends for at least 25 years. "It's the growing dividend that's really important for people, because otherwise you won't have a portfolio that outpaces inflation," says Farrell.

To get the advantages of dividend-paying stocks without buying individual shares, consider an equity-income mutual fund, in which a professional manager chooses the stocks in the fund. Managers look for dividend-paying stocks that also have the potential to appreciate in price (offering solid total return). Examples include the Vanguard Dividend Growth Fund (VDIGX) and the T. Rowe Price Equity Income Fund (PRFDX).

Corporations Have Big Cash Stockpiles

Investors should also consider value funds, says Brown, even if they are not dividend-specific. "If it's truly in the value category, almost assuredly it will have reasonably good dividend yields because those are the kinds of stocks they are going to be buying," says Brown. He advises investors to diversify their portfolios with a mix of large-cap, small-cap and international value funds, which may also contain bonds.

Also consider an exchange-traded fund that focuses on dividend-paying stocks. ETFs track the performance of specific market indexes – such as the S&P 500 – but trade like stocks. (Mutual funds, by contrast, are priced just once a day, when markets close at 4 p.m. Eastern.) ETFs often claim to be have lower costs and better tax-efficiency than mutual funds (although some studies have found low-cost mutual funds can beat ETF returns). Examples include the iShares Dow Jones Select Dividend Index (DVY), the SPDR S&P Dividend (SDY) and the recently launched Schwab U.S. Dividend Equity (SCHD).

Whether you choose a mutual fund or ETF, make sure the basket of investments isn't dominated by a handful of big names, says Farrell. Most of the broad market indexes, such as the S&P 500, are "market cap-weighted" -- meaning the index holds a larger percentage of the biggest stocks. Wild price swings in those shares can have a dramatic effect on the overall value of the index, fund or ETF.

The outlook for dividend growth is positive, given that companies are sitting the biggest stockpile of cash in nearly 50 years.
"There's plenty of money that can be delivered to shareholders through increased dividend payouts," says Farrell.

If you do choose the route of simply buying a diversified basket of dividend-paying stocks, be prepared to ride out the market's ups and downs, advises Brown. "You can buy individual stocks right now with a 4% to 6% yield, but you've got to be prepared for the downturn and say, 'I believe this stock is not going out of business and will eventually recover,'" he says. "Take the dividend check and be happy and don't pay attention to the volatility. A lot of people say they can do it until the price drops by 20% to 25%, and then they're not so sure."

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carringtonmktg

Sounds like Bob needs to talk to me cause I utilize a guaranteed income stream of 6 percent that me and my wife can't outlive and still leave our principal as a legacy for our kids..

December 06 2011 at 6:03 PM Report abuse rate up rate down Reply
simpsongrsm

Questionable advice. Especially is you are 70 years of age. If you must risk your money, dividend paying mutual funds are the only way to go! Right now, the market is up dramatically, Dow was at 9500 or so not to long ago - it has had a great run - buying now may NOT be prudent. If you must risk your money - wait until there is a pullback. The Federal Reserve is the real cuprit - damage done by Bernanke is beyond belief - and the Fed is not done yet - more damage to come - count on it with OE3 - more treasury buying. Inflation is a certainty - an absolute certainty - that is when the real pain will hit the middle class. Obama is a threat to the American way of life - totally clueless!

November 16 2011 at 1:11 AM Report abuse rate up rate down Reply
Darrell & Donna

Thanks to GREENSPAN and Bernanke we are all paying the price for their bull @#@# to congress;;It will be 20 years before you get a return on your savings they just print more money;;get rid of the feds elect Ron Paul'''

November 15 2011 at 7:20 PM Report abuse +2 rate up rate down Reply
1 reply to Darrell & Donna's comment
savemycountry911

20 years? Try 50.

November 15 2011 at 8:30 PM Report abuse +1 rate up rate down Reply
toosmart4u

Remember when doing your Christmas shopping to buy American and help put all Americans back to work no matter what you plan to buy.

November 15 2011 at 4:08 PM Report abuse +1 rate up rate down Reply
scottee

an alternative to low interest rates would be to END THE FED.

November 15 2011 at 2:45 PM Report abuse +1 rate up rate down Reply
thescot

Tax free municapal funds are also good, plus you get dividents every month and if you live in the state that issues the bonds that the fund is made up of, you are totally tax free.

November 15 2011 at 2:43 PM Report abuse rate up rate down Reply
Mickylitz

tjdwill02
Look out mick, you'll receive the " wrath" of 'Chicaga Chris'. He bleeds Obama Blue !
****************************************************************************************************
Not to worry tjdwill02 , I don't let the Chris's 1011 or ( 2011 ) get to me , I couldn't never be swayed by any compliments nor insults or threats by the members of his camp.

November 15 2011 at 12:58 PM Report abuse rate up rate down Reply
dabrownman

I have a combination of NGG, RQI, IVR, EXC, BP and AGNC that pays me over a 12.5% dividend.

November 15 2011 at 12:39 PM Report abuse rate up rate down Reply
wburwell14

No. I was with me. Years ago I had a broker buy stock. When I got the bill the price I paid was the price of ths stock
3 days later. He was also the one that said don't buy Microsoft and Yahoo. I have bought and sold on my own for several years. I was way ahead went the stocks tanked. I had been looking at Limited Partenerships. The have to pay
a dividend every 3 months. I didn't move fast enough but when the smoke cleared I invested in the LP's. Most of mine arein natural gas, oil and pipe lines. They should be around long after i'm gone.

November 15 2011 at 11:56 AM Report abuse rate up rate down Reply
2 replies to wburwell14's comment
chris1011

Like you, I also invested in Limited Partnerships. Have done very well. Bought at the bottom of the crash in '09 when the prices were down 40% and more. Not only have they come back, the dividends are 6% to 14% for the various partnerships. I don't think gas is going away any time soon. Right now I'm buying utilities, which have also bottomed out. Dividends for Excelon is close to 5%, and they recently won a rate increase for expansion.

November 15 2011 at 12:11 PM Report abuse rate up rate down Reply
1 reply to chris1011's comment
dabrownman

I like the REITs. Some still pay a 20% Dividend and are a good fit in small amounts for any income portfolio

November 15 2011 at 12:57 PM Report abuse rate up rate down
Mickylitz

wburwell14

Better watch out for your oil and pipe lines stocks, if we keep the democrats in power you will lose your shirt .

November 15 2011 at 12:14 PM Report abuse -3 rate up rate down Reply
3 replies to Mickylitz's comment
nsoccio

Gee wburwell thats great you the first person that I heard of that has made $ in the stock market in the last 10 years. Just crunching your numbers it sounds to me like a 12% return. Are you sure you wern't investing with Bernie Madoff.

November 15 2011 at 11:32 AM Report abuse +1 rate up rate down Reply
1 reply to nsoccio's comment
dabrownman

I can't think of anyone I know who did not make substantial money in the market over the last 10, 20, 30, 40 year time frames. Those that didn't were the fraidy cats who bought at the top and sold scared at the bottom. With the Markets being a zero sum game, many lost a lot and a few won a huge, gigantic ton of money. They weren't smarter but they avoid all FEA PRIDE AND EGO the only 3 things that cause failure each and every time

November 15 2011 at 1:03 PM Report abuse rate up rate down Reply