Tuesday, February 21, 2012

Six Myths About Investing in Dividend Stocks

Rebecca L. McClay had the following dividend story at MarketWatch. Don’t dismiss dividend-paying stocks

Lawrence Carrel, author of Dividend Stocks for Dummies, advocates for dividend-heavy portfolios, saying volatile markets are a ripe time to pick paying stocks. With stock values unpredictable, investors find comfort in knowing that they will at least be paid the dividend even if they lose out on stock value, he said.

More people want the income from dividend stocks now. they’ve had an awakening, Carrel said. They are not gung-ho about growth anymore.

In his book, Carrel outlines several myths that investors harbor about dividend-paying stocks.

Myth 1: Avoid dividend-paying stocks in volatile markets

On the contrary, Carrel sees rocky times as the right time to invest in stocks where you can recoup profits without selling the shares.

In general, it’s a little less risky, Carrel said. There’s the idea that if I’m going to be in an environment and I can’t be sure where the stock price is going to be, at least I will be able to walk away with profits from dividends.

Basil Herzstein, a financial planner with Gallers Financial in Rockville, Md. agrees. Dividend stocks have a built in base so that investors have cushion against market drops, he said.

He points to companies that have weathered the recession well, like GE (GE). with a yield of 2.5%, The Blackstone Group (BX). with a yield of about 4%, Microsoft (MSFT). with a yield of 2%, and Annaly Capital Management (NLY), with a yield of 15.2%.

In the crappy market that we are in, these stocks have held their value and they’re giving me a yield on my money, Herzstein said.

Myth 2: Dividend-paying stocks will give your wallet a quick boost

While paying stocks can add wealth in the long-run, don’t expect them to offer fast returns. Instead, dividend-paying stocks are a good idea if you are buying for the long-term. Herzstein says he is looking eight to 10 years out when he selects stocks.

Anybody who believes they can just double their money in a few months — it’s not going to happen, Herzstein said.

Myth 3: Companies that pay dividends will limit their growth

Traditionally, companies that pay dividends are well past their growth phase, but just because a company is issuing dividends doesn’t mean it’s not growing. Jon Ten Haagen of Ten Haagen Financial Group in Huntington, N.Y. advises investors to look for companies that are not paying out too much in dividends so that they can continue to grow.

Be careful, because some are paying out 90% of their earnings as dividends, which doesn’t give them much to invest back into the company, Ten Haagen said.

Myth 4: You should always invest in high-yield stocks

High yields are a plus, but investors should first consider the company’s basic financial standing when selecting dividend stocks, Ten Haagen said. Yields shouldn’t be the first priority. Instead, find the sector of the market that you like and then search for companies that seem undervalued. Be very selective about the quality of the company and consider the dividend as a bonus, not a deciding factor.

I think of dividends as the icing on the cake, Ten Haagen said.

Myth 5: Dividend increases will not keep up with inflation

Dividends have historically kept up with inflation rates and then some, proving to be a big component of investors’ overall return, said Gil Armour of SagePoint Financial in San Diego. While aggressive growth-oriented stocks often are the first to fare well during an economic recovery, Armour said that more stable dividend-paying value companies will be soon to follow. Armour predicts that established, dividend-paying stocks will be the cream that rises to the top in the next few years.

Myth 6: Dividend investing is for retirees

Dividend stocks tend to attract older investors, but they can benefit people of any age, as long as you don’t expect fast returns. Dividend stocks create wealth over the long-run, not through a few payments. Armour said everyone should have exposure to both growth stocks like technology companies and value companies with dividends.

It makes sense — they tend to go in and out of favor, Armour said. However, older investors who need regular income might, indeed, want to weight investments in dividend-paying stocks.

Carrel, who says investors of all ages should maintain dividends for at least 50% of their portfolios, argues that younger people can use the power of compounding to significantly grow their portfolios in the long-run by reinvesting the dividends.

If you follow a dividend strategy, especially if you’re young, the power of boosting your portfolio in the long-run is very strong, Carrel said. Over time, it grows exponentially.

Disclosure: The Div Guy owns share of GE at the time of this post.