There are troubling times for anyone trying to build a retirement nest egg. Because of credit meltdowns and government debt problems around the world, economies are seriously sputtering -- which means the market remains stuck in second gear.

The Standard & Poor's 500 Index ($INX) has advanced only 11.3% over the past decade and trades at levels first reached a couple of years before that. It's hard to build your 401k or individual retirement account when you're getting that kind of return.

What's worse, it may be a while before stocks break out again. Investors are so shell-shocked they are avoiding risk, shunning stocks for the perceived safety of cash or bonds. That doesn't help stock prices.

But there is way to keep your retirement plans on track -- pulling down a regular cash return that beats CDs or money-market funds, without missing out on the growth of stocks when the market turns up.

Bulk up on dividend-paying stocks.

Dividends fell out of favor during the go-go-tech days a decade ago, and they're often dismissed as tools for grandfathers in today's high-speed, trade-happy markets. But dividend-paying companies offer lots of advantages for all investors, in shaky times and in good times.

Image: Michael Brush

Michael Brush

I've got a list of dividend funds and stocks for you that can help keep your nest egg growing. But first, here are the top three reasons dividend-paying stocks make so much sense right now:

1. Dividends pay

The most basic reason to bulk up on dividend stocks is that you get paid for owning them -- something that's particularly important right now, with bonds providing paltry returns. Since 1970, 10-year U.S. bonds have paid a yield that's typically 2.5 times more than the average yield on S&P 500 stocks. But right now, the S&P 500 pays a bigger yield than bonds for only the second time in 40 years, says Derek Rollingson, who manages the Icon Equity Income (IOEIX)fund.

In other words, dividend-paying stocks are a better source of income right now than bonds, something that may continue for a while with policymakers vowing to keep interest rates down.

Just two little facts show how critical dividend payments can be:

  • From January 1926 through June 2011, the S&P 500 returned an average of 9.97% per year. Reinvested dividends -- payouts plowed back into their stocks -- accounted for 41.7% of that return, according to Standard & Poor's.
  • And that 11.3% return for the S&P 500 stocks over the past 10 years actually triples to 35.2% if you include reinvested dividends, says Standard & Poor's.

2. Dividends provide safety

Regular payouts represent safety -- on many levels. First, dividends are a public statement of confidence by company boards and managers. They know stocks get crushed if a dividend is cut, so the promise to pay dividends provides a strong incentive to make honest promises and deliver results. Plus, dividends are real evidence of actual performance. Companies can fudge a lot of numbers, but a payout is a payout.

Next, dividends offer steady, real returns. They represent "a tangible return on investment that the market can't snatch away from you as it can a paper profit," writes Kelley Wright in his book "Dividends Still Don't Lie."

This means dividends will help you make up lost ground in a down or sideways market like the one we seem to be stuck with. That helps you build your retirement nest egg and also means you can sleep during volatile times like these, says David Abella, who manages the Rochdale Dividend & Income (RIMHX) fund. "Dividends make a world of difference in terms of investor psychology."

Finally, because a lot of investors gravitate to dividend-paying companies, dividends act as "an anchor for investor interest in a stock," says Abella. And high investor interest buoys prices.

3. Dividends offer an inflation hedge

This is one advantage stocks always have over bonds, the traditional cornerstone of an income-producing portfolio. A 10-year government bond will always offer the same payout. A company with a history of increasing dividends will likely continue to do so, providing protection against inflation.

Of course, the risk is that you can lose money owning a dividend-paying company if its stock sinks. But if you select carefully and stick to time-tested companies, share prices of the companies you pick aren't likely to stay down over the long haul, say five or 10 years.

So how do you plug dividends into your retirement accounts? Start with mutual funds.

Testing dividend funds

Here, the same rules apply as with any fund. Go with managers who have good track records and long tenures, so that they've been tested in different kinds of markets, says Christopher Davis at Morningstar. That means at least five to seven years. Next, look for low fees -- 1% or less for a domestic fund with an active manager picking stocks, and 0.3% or lower for index funds, as a general rule.

With these guidelines in mind, I hunted through Morningstar's database to find funds that rank among the best performers in this category.

For the superlow-cost approach, consider the Vanguard Dividend Appreciation (VDAIX) fund. It tracks a proprietary index of companies that have increased dividends in each of the past 10 years. The fund pays a 2% dividend yield, but its holdings are likely to raise dividends nicely because they have solid expected earnings growth, says Ryan Leggio, of Morningstar.

Among managed funds, Rochdale Dividend & Income, Icon Equity Income, and Neuberger Berman Equity Income Institutional Fund (NBHIX), all rank high for three or five-year performance. They pay yields ranging from 3.8% to 4.25%. Rochdale Dividend & Income charges a load, or entrance fee, of 5.75%, but its consistently solid outperformance might make up for that, if it continues. The fund has beaten peers by an impressive 5.2 percentage points a year, annualized, over the past five years, according to Morningstar.

I'd also suggest breaking one of the rules to consider a newcomer, the THodges Equity Income Retail (HDPEX) fund, because of its results. The fund has outperformed peers by 5.6 percentage points over the past year. It pays a 2.7% yield.

For utility funds offering high yields, consider the Icon Telecommunications & Utilities (ICTUX). It charges a little more in expenses than I'd like, but it has outperformed peers by an annualized 5.4 percentage points a year over the past 10 years, according to Morningstar. The Gabelli Utilities AAA (GABUX) fund pays a 13.7% yield and outperforms peers by more than a percentage point a year, annualized over the past 10 years.

You shouldn't have much problem getting one or more of these into your IRA; if your 401k doesn't offer them, look at your plan's offerings based on the criteria above.

Now, let's look at some of the top dividend-paying stocks that the managers of these funds favor, and their yield, or payout, as I was putting this column together:

AT&T: 6.1% yield

AT&T (T, news) is often the butt of jokes about dropped calls. These customer service issues, and concerns about the economy, help explain why its stock trades where it did in early 2009. But AT&T's stock weakness means a high yield. And AT&T remains a dominant player in wireless, where demand is going to keep growing. "This is one of the more stable cash cow businesses right now in the U.S.," says Abella.

McDonald's: 2.8% yield

McDonald's (MCD, news) has one of the strongest brands in the world, and it's expanding in emerging markets. At home, McDonald's has had solid success rolling out new offerings; it's also upgrading restaurants and offering free Wi-Fi to get customers in the door. Stable cash flow and growth should mean regular dividend increases ahead. This probably explains why McDonald's is the top holding of the Vanguard Dividend Appreciation Index fund.

Bristol-Myers Squibb: 4.5% yield

Lots of major pharmaceutical companies pay high dividends and look cheap right now, because their stocks have been beaten down by concerns about patent expirations on blockbuster drugs. But Bristol-Myers Squibb (BMY, news) stands out as the premier yield play in this space because it has a much better pipeline of drugs in development, says Abella. "Bristol-Myers Squibb is a way to play the attractive valuations in pharma with less pipeline risk," he says.

Philip Morris International: 3.8% yield

Cigarettes are terrible for your health, and people shouldn't smoke. But if you can get around the qualms, Philip Morris International (PM, news) is a great yield play. Philip Morris sells powerful brands like Marlboro in dozens of markets outside the U.S., producing enormous cash flow to back dividends. That's why Abella has found a place for Philip Morris in his dividend portfolio even though, like me, he's not a big fan of smoking.

Southern Copper: 7.9% yield

Based in Phoenix, Southern Copper (SCCO, news) is one of the world's largest copper producers. It has low debt for a mining company, which helps make the sweet 7.9% dividend yield more secure. This is a favorite of Rollingson, at Icon Equity Income Fund. Rollingson estimates Southern Copper trades 22% below fair value.

Union Pacific: 2.1% yield

The largest publicly traded railroad in the U.S., Union Pacific (UNP, news) operates in the western part of the country, hauling everything from coal and chemicals to toys from China. Shipping by rail is less expensive for long distances than trucking, which means Union Pacific should continue taking market share, says Eric Marshall, an analyst with the Hodges Equity Income Retail fund. The railroad's recent 25% dividend hike and ongoing large share repurchases are signs that management is confident about the future.

Utilities

No dividend portfolio is complete without utilities. And the wild days of Enron are over; utilities are generally safe investment plays once again, says Mario Gabelli, of the Gabelli Utilities AAA fund.

Two that look particularly secure are Wisconsin Energy (WEC, news), which pays a pays a 3.3% yield, and CH Energy Group (CHG, news) in Poughkeepsie, N.Y., which pays a 4% yield, says Tim Winter, who follows utilities for the Gabelli Utilities AAA Fund. Both utilities are likely to raise dividends, he says.

Robert Straus, of the Icon Telecommunications & Utilities fund, thinks two other utilities stand out because they are trading at significant discounts to his calculation of their fair value. One is Southern (SO, news), his fund's largest holding. It pays a 4.5% yield. The other is Duke Energy (DUK, news), a top-10 position in his fund. It pays a 5.5% yield. Both companies have paid dividends consistently since the late 1970s.

Stocks for your retirement

The hitch here, of course, is that if your nest egg is in a 401k, you're probably not allowed to put stocks in it. You'd need to open up a self-directed brokerage account inside your 401k, something more employers are allowing, says Dave McDonough of Flagship Wealth, a financial advisory firm in Quincy, Mass. So ask at work, but realize it's a major change.

Here's an easier way: If, like most of us, you're a little behind in your retirement saving, consider buying these dividend stocks above in a private retirement fund to supplement your 401k, while also looking for dividend funds in your plan.

And of course, there's no guarantee any investment will pay off for you, not even those that pay dividends. But I've tried to stick here with picks recommended by top experts and funds with very solid records that look likely to keep the dividend payouts rolling. Keep an eye on any investments you buy to make sure they do.

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Because a steady stream of dividend payouts will keep your nest egg growing, even while the market remains flat.

At the time of publication, Michael Brush did not own or control shares of any company or fund mentioned in this column. In the past year, he has suggested that his newsletter subscribers consider purchasing shares of Philip Morris International.

Michael Brush is the editor of Brush Up on Stocks, an investment newsletter. Click here to find Brush's most recent articles and blog posts.