5 ways dividend stocks can save your portfolio

Investing for yield isn't timid. It's downright smart.

By InvestorPlace Jan 18, 2012 10:34AM

 Image Source/CorbisBy Jeff Reeves


Think dividends are for lazy, below-average investors who are content with simply tracking the market? Think again. Dividend investing could be the only way to preserve your wealth right now.


But more important, dividend stocks don't just preserve wealth, they can constantly build your retirement funds through a steady stream of income. Don't underestimate the power of a regular payday, especially if the yield is 5%, 6% or more. Who in his right mind would pass up 6% annual returns in this choppy market?


Still convinced that long-term dividend investing is a strategy for the timid? Then check out these five compelling reasons to consider dividend stocks.


1. Dividends are only getting bigger from here. This may be your best opportunity to get into the dividend game. If you look at the historic yield of the S&P 500 index, you'll see that yields have been steadily moving upwards. (Thanks to my friend Eddy Elfenbein of Crossing Wall Street for the data for this chart.)

This is in large part due to high-growth tech stocks maturing and moving beyond disdain for dividends. Consider Microsoft (MSFT), which has doubled its quarterly payout over the past five years, from 10 cents to 20 cents, for a 2.8% yield. Intel (INTC) has also doubled its dividend since 2007, from 11.25 cents to 21 cents for a 3.3% yield. And in 2011, Cisco (CSCO) started paying its first dividend. (Microsoft owns and publishes Top Stocks, and MSN Money site.)


This is alongside other traditional dividend payers upping the ante -- like McDonald's (MCD), which has boosted its payout from 37.5 cents a quarter in 2008 to 70 cents currently, for a 2.8% yield.


True, yields pop higher during a down market and slump during a rally because they're calculated as a percentage of share prices. But the trend in stocks can't be ignored, and dividends appear to be moving steadily upward.


That means the stock you buy now with a 10-cent payday could easily pay 12 cents, 15 cents or even 20 cents several years down the road. Even if you're not impressed with a current yield of around 2% or 3%, over time your yield on cost could rise dramatically because of dividend increases.


2. Dividends help you 'average in' or buy new opportunities. Burton G. Malkiel, the author of "A Random Walk Down Wall Street," has written many times in the The Wall Street Journal defending buy-and-hold investing. And one of his selling points is dollar-cost averaging, which most investors are familiar with.


The idea is that buying a stock at regular intervals hedges your bets. You put a set amount of money in the market when stocks are high but also buy at market bottoms. By investing the same amount, you get more shares when prices are low, thus lowering average costs. Market timing is a tricky business, so dividends will allow you to keep buying  at regular intervals to avoid buying a top. And they offer an influx of new capital that allows savvy investors to seize new opportunities.


3. Dividends guarantee market-beating performance. Don't want to reinvest those dividends? Then just sit on them and enjoy the extra returns granted you by mere virtue of owning stock.Considering the hucksters out there who "guarantee" market-beating performance every year with their stock picks, you'd think someone would start marketing dividend reinvestment along similar lines. While some of those snake-oil salesmen will likely fleece their customers in exchange for ugly stock picks, reinvesting dividends always works -- and requires no costly advisory fees or crazy trading methods.


Here's why: Let's say you buy an index like the S&P or Dow, with the exact same makeup of stocks. The index's return is your return, and the dividends are gravy.


Obviously, if the market goes down, so will your portfolio. However, the dividends provide additional returns -- in good times and bad -- that guarantee your profits will be bigger and your losses will be smaller.


4. A little outperformance goes a long way. Granted, 2% or 3% in extra returns can easily be replaced by just one or two more profitable trades. If you were overweight in Apple (AAPL) across 2011, for instance, the tech giant's 20% gains could have easily skewed you into market-beating returns.


But consistently making moves like that is a tall order. And over the long term, squeaking out that extra 2% or 3% annually can supercharge your portfolio.


For instance, while everyone likes to talk about how the S&P 500 finished flat for 2011 or call the index "dead money" going back 10 years, such statements oversimplify the numbers. True, the index's nominal reading may be at those levels. But when you consider the "total return" with dividends included, the results are much different.


Consider that while the headline S&P reading is up around 70% since 1997 (from roughly 750 to a current reading around 1,300), when you add in dividends the index is up almost 120% in the same period!


Again, you could have replicated those returns with some savvy buys. But if stock picking were easy, we'd all be millionaires. So unless you're supremely confident in your abilities, it's a safer bet to rely on dividends for long-term outperformance.


5. What else is there? Perhaps the most compelling reason to invest in dividend stocks right now is that there aren't a lot of alternatives.


U.S. Treasurys with a 10-year maturity now yield a paltry 1.86%. That doesn't even keep pace with inflation, though it's admittedly better than cash, which delivers zero return.


Gold hit a record in 2011 and then plummeted. It's now trading 15% below its peak despite a recent rebound. Commodities are notoriously volatile, and gold is no different.


The stock market has been swinging wildly up and down as the eurozone debt crisis and looming presidential election whipsaw sentiment-driven runs largely unrelated to the news. Risks are awfully high right now if you're going to bet on a stock delivering profits on share value alone.


But most dividends offer a reliable stream of income for your retirement funds. Even if share prices drop in the short term, you'll keep getting paid.


Of course, no investment is risk-free, and not even blue-chip dividend payers are a sure thing. There are always dividend horror stories like General Electric (GE), which slashed its payout by two-thirds at the height of the financial crisis. Or stocks can crash, offsetting any quarterly paydays you get.


But dividends offer a reliable stream of income for your retirement funds. Even if share prices drop in the short term, you'll keep getting paid. The environment right now seems to favor dividend investments above all others -- especially for investors who believe in a buy-and-hold strategy.


Now that you've wrapped your head around why investing in dividend stocks is a smart way to build your portfolio, here are five more steps you can take to make an all-weather portfolio for both bull and bear markets.



Jeff Reeves is the editor of InvestorPlace.com. Write him at editor@investorplace​​.com, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. Jeff Reeves holds a position in Alcoa, but no other publicly traded stocks.



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6Comments
Jan 18, 2012 1:18PM
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For me the cost averaging of DRIPs in this environment is reason enough to have them in my portfolio. But there is one additional reason I've always liked boring old dividend stocks. The old saying was that dividends keep companies honest. It's a little harder to cook the books for too long if you have to put your money where your mouth is...
Jan 18, 2012 2:08PM
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Like Fatuus Secundus, I also like boring old div stocks. A while back, I converted our retirement investments from mostly growth stocks into investments whose primary objective is to generate income, the composition is roughly 65% div stocks, 30% bond ladder, and 5% money market.  Since then, our income return has been 7.9% of original buy in cost. Not glamorous, but I will settle for that any day, a consistent and predictable source of income to supplement our pensions and SS to let us live confortably in retirement.  Yes, if we eventually get into another bull market (and no, I'm not predicting that, but no one knows the future for sure), then most likely div stock share price will underperform the overall market.  But as Tommy Lee Jones said in The Fugitive: "I don't care!".  Have a good day.
Jan 18, 2012 1:36PM
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Jeff, on October 26, 2011, you posted a blog that listed several Dow stocks to not buy now.  McDonald's was one of them.  Today you recommend McDonald's.  What changed?
Jan 18, 2012 3:39PM
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In a market like we had in 2011, dividend stocks were one of the few places you could put your money and at least get some kind of return.  It was a very unforgiving market for companies, such as Netflix or Riverbed Technologies, with high P/E multiples that stubbed their toe or missed an earnings forecast.  

We'll see what 2012 brings.  If there are positive signs that the economy is growing and that Europe isn't going to crash and burn, maybe it will be time for growth stocks again.  But at least for now, I'll stick with the boring high yield stocks (with the exception of Apple).
Jan 19, 2012 7:19PM
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Smile Another reason dividends are good is that dividends tend to put a floor under a stock's price. As the stock goes down, the percentage dividend goes up enticing more people to buy the stock which supports the price per share.
Jan 18, 2012 12:06PM
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that dividend really helped protect carnival
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