Ner­vous? Me? No. You?

It’s no secret that there is a lot of con­cern amongst div­i­dend investors these days; it seems that every­body and his dog in the finan­cial press is ask­ing (and then answer­ing) the ques­tion: Is it time to get out of dividend-paying stocks? (Some peo­ple are even mess­ing with their read­ers, includ­ing Robb, over at Boomer & Echo .)

Gen­er­ally, their answers are: No, you shouldn’t dump your div­i­dend stocks. Why? Because:

• inter­est rates may yet stay where they are for some time, so don’t leave the party early; mar­ket tim­ing is a mug’s game
• a prop­erly diver­si­fied port­fo­lio is already pre­pared to take advan­tage of a rise in inter­est rates if and when it comes
• stock pick­ing and sec­tor rota­tion are not games that most indi­vid­u­als can win on a con­sis­tent basis; it is far bet­ter to pick your strat­egy and stick with it.

That’s all well and good, but that doesn’t answer the ques­tion that I’ve heard posed around the water cooler a few times recently: If ris­ing inter­est rates are ulti­mately a sign of a healthy econ­omy, why are peo­ple wor­ried about div­i­dend stocks falling? Here’s why:

To under­stand the answer to this ques­tion, you have to under­stand what bonds are, and how they work. Bonds are loans that investors make to com­pa­nies or gov­ern­ments. The com­pa­nies or gov­ern­ments pay inter­est on those loans at pre-determined rates for a pre-determined amount of time, and then the orig­i­nal cap­i­tal is returned to the investor. Bonds are con­sid­ered among the safest of invest­ments. If a com­pany goes under, the bond hold­ers are the first to get paid when the company’s assets are divided up. Also, unlike div­i­dend pay­ments, bond inter­est pay­ments are a legal obligation.

With inter­est rates so low over the past years, bond investors have been forced to look else­where for yield. In terms of pre­dictabil­ity and secu­rity of income, divendend-paying stocks are only one rung below bonds — a big rung, to be sure – but the next best alternative.

Div­i­dend investors chuffed

The result of all of these new stock investors (i.e. the for­mer bond investors) jump­ing into the stock mar­ket is that the price of many dividend-paying stocks has climbed higher, as there are more and more buy­ers for these large, liq­uid, rel­a­tively sta­ble com­pa­nies. This is pri­mar­ily what has dri­ven the prices of these com­pa­nies up over the past few years. Many of the peo­ple who were in div­i­dend stocks when this started (myself included, I have to admit) have been feel­ing the thrill of the buy low, sell high investor, as prices have risen ever higher.

Ris­ing prices have attracted traders, push­ing prices higher yet. While the party lasted, every­body was hav­ing a great time.

The fat lady is just about fin­ished warm­ing up

Now that inter­est rates look set to rise again, bond investors will go back to what they know: safe, secure, reg­u­lar bond pay­ments. Of course, to invest in bonds, they will have to sell their stocks. Large num­bers of peo­ple sell­ing large num­bers of shares inevitably leads to lower prices. Traders, see­ing the writ­ing on the wall, don’t want to get caught hold­ing the bag, so they sell as well, and the result is falling stock prices, like we have had over the past month or so.

To me, it seems inevitable that the recent drops in dividend-paying stocks will con­tinue over the next sev­eral months. How far, and how fast prices will fall, I have no idea, but the direc­tion seems sure. The most impor­tant thing for div­i­dend investors to remem­ber is to focus on the num­ber that really mat­ters: not the total value of the port­fo­lio, but the amount of money your stocks gen­er­ate for you.

So, no, don’t sell your dividend-payers.