As of this writing, it appears that 2018 may be a difficult year for investors who seek relatively safe investments. Yields on bonds, bank accounts, money market funds, and other savings vehicles are extremely low, with questionable prospects for substantial increases. In essence, relatively low-risk places to put your money this year appear to offer scant returns.
Stock market indexes, on the other hand, are at or near record levels. But equity markets have been rising since early 2009, so the chance of a pullback in the broader stock market may be just as great as the possibility of solid gains.
Given this environment, where might investors go for opportunities for respectable returns with some protection against a steep decline? One possibility is in dividend paying stocks.
Paying dividends
Equity markets are notoriously difficult to predict. Nevertheless, dividend paying stocks might tilt the risk-reward odds in your favor.
During recent bear markets, dividend payers generally fared better than those that didn’t pay dividends. This seems reasonable because dividend paying companies may be enterprises that generate ample cash flow – enough to distribute some profits to investors. Companies in strong financial condition could be favored by investors in stormy economic weather, and the prospect of ongoing dividend payouts might stem panicked selling.
In addition, qualified dividends receive favorable tax treatment. Investors in a low tax bracket could owe as little as 0% on qualified dividends. Other taxpayers owe 15% or, for those in the highest ordinary tax bracket, 20%. These rates are lower than ordinary income tax rates. The Trump Administration’s tax reform framework, released in the fall of 2017, does not mention the possibility of ending this tax break, but as of this writing proposals for tax reform have not been finalized.
Go with a pro
It’s true that dividend paying stocks can offer many advantages. However, investing in equities carries risks; even the most established company, with excellent management, can see its share price tumble in a broad selloff. Selecting individual dividend paying stocks can require thorough research and portfolio monitoring.
Therefore, many investors prefer to invest in mutual funds or ETFs that focus on dividend stocks. There are dozens of such funds available, with portfolio managers who are responsible for stock selection. Other funds track a custom index of dividend paying stocks. Dividend stock funds tend to fall into two broad categories:
- High payout. Some funds are designed to pay higher yields than the S&P 500. They may use “dividend capture” strategies, buying funds just before a dividend payout. High dividends may be appealing, but a robust payout can indicate a relatively low share price due to concerns about the company’s growth prospects.
- Dividend growth. These funds may have yields similar to the S&P 500 or lower. However, the stocks they hold are chosen because the companies have enjoyed growing earnings along with rising dividends and are considered likely to continue such profitability.
Quality counts
Dividend oriented investors may hold individual stocks, specialized funds, or a combination. They aim to own successful, profitable companies that will provide a steady stream of cash flow, bull market or bad. There’s no magic about dividend paying stocks and there have been instances in which a dividend cut has been followed by a plunging stock price. Still, buying successful companies that pay appealing dividends is one way to approach equity investing this year, with current prices at lofty levels.