If you are a dividend investor, you may feel like you're sailing into a stiff wind. But by setting your course carefully, you can find reliable dividend income that will keep your portfolio cruising.
Just don't expect the calmest seas ahead. Companies in Standard & Poor's 500-stock index, which have produced four consecutive years of record dividend payments, are beginning to sharply curtail dividend growth. Meanwhile, the strong U.S. dollar is dragging down the results of many multinational companies favored by dividend investors. Another threat to dividend payers looms with rising interest rates, which can lure conservative investors out of stocks and into bonds. Perhaps most painfully, the oil-price plunge has pummeled the energy sector, which accounts for more than 10% of S&P 500 dividends, and prompted some high-profile dividend cuts.
Some older dividend investors are calling it quits. Since retiring in 2009, 64-year-old
Yet this may be precisely the wrong time to dump high-quality dividend-paying stocks. While some dividend payers -- most notably those in the energy sector -- have suffered, well-diversified funds holding companies with strong balance sheets and a history of growing dividends have actually offered investors much-needed shelter in this market storm. The blue-chip-focused
And with bank accounts and high-quality bonds still offering paltry yields, most retirees can't afford to ignore the income that's available in stocks. The S&P 500's 2.4% yield may not sound like much, but it looks generous compared with the 1.7% yield of the 10-year Treasury. "Very few people can live off of 2%," says
Investors who have grown accustomed to the brisk dividend increases of recent years will have to reset their expectations. In the fourth quarter of 2015, U.S. stocks' dividend net increases (that's dividend hikes minus dividend cuts) amounted to
In a world of slowing dividend growth and potentially rising rates, your dividend-investing strategy may need some tweaks. If you've been focused purely on dividend growth -- buying low-yielding stocks or funds with strong potential to boost payouts -- you may be setting yourself up for disappointment. If dividend growth decelerates, "now you don't have much of a yield to fall back on," says
If you've been focusing on the highest-yielding stocks you can find, you may also want to adjust your strategy. Higher-yielding stocks may be hurt more when interest rates rise, as conservative investors dump these riskier holdings to take advantage of higher yields in the bond market.
The solution: Stake out the middle ground. High-quality stocks with moderately high yields of roughly 3% to 5% and meaningful growth rates should hold up relatively well even if dividend growth slows and rates rise, advisers say.
Finding Dependable Payers
Dividend cuts can rob retirees of money they were counting on to cover living expenses, and they have a depressing effect on stock prices. Looking at rolling 12-month periods between 1972 and the end of last year,
To reduce your risk of suffering dividend cuts, first look at the yield of any stock you're considering buying. A sky-high yield can be a warning sign. "If you see something with an 8, 9, 10% yield, very rarely is that going to be a screaming bargain," Peters says. Most of the time, "it's a dividend that's in imminent jeopardy of being cut."
Also be wary of stocks with a high yield relative to their industry peers. For example, "even a 5% yield might be too high for packaged food companies," Peters says. These stocks typically yield 2% or 3%.
Use Web sites such as Morningstar.com or Yahoo Finance to check out a company's financial strength and dividend history. Farrell looks for companies with low debt and "a consistent pattern of dividend growth that roughly tracks the company's long-term earnings growth." That suggests the company is committed to returning cash to shareholders but isn't paying out more than it can afford.
Playing Dividend Defense
Amid all the volatility, where can you find steady dividend payers that offer meaningful income and good growth potential? Many money managers and analysts point to some of the market's most defensive sectors -- utilities and consumer staples.
Utilities have a reputation for offering very little growth. But that's changing, Peters says, as many utilities invest huge sums in improving reliability, connecting renewable energy sources to the grid and installing "smart meters" that help improve tracking of energy use. The result: "What you have across wide swaths of the utility industry is some of the best earnings growth trajectories that you've had maybe in decades," he says. "I'd rather own those names in a slow-growing economy than a lot of other stocks."
Peters' favorites include
The strong U.S. dollar has weighed on consumer staples, because many of these companies generate a sizable chunk of their sales overseas. While currency fluctuations cause short-term bumps, their effect tends to be "neutral over the long term," says Daniel Peris, manager of the
Some consumer-staples giants that are currently in turnaround mode can offer investors attractive income along with growth potential. Procter & Gamble (PG), maker of Tide laundry detergent and Bounty paper towels, has struggled in its attempts to enter new emerging markets and is now selling off many of its brands and cutting costs. "They're on the path to recovery," says
Davidson also likes
Real Estate and Other Promising Sectors
Some investors are wary of real estate investment trusts in an era of rising rates, which tend to depress property values and boost REIT borrowing costs. But REITs have posted positive returns in four of the six periods since the early 1970s when the 10-year Treasury yield rose significantly, according to Standard & Poor's. And in half of those periods, REITs beat the S&P 500.
REITs are actually "in a sweet spot here," says
One of Pomeroy's REIT holdings is
Peters also sees strong growth ahead for health care REITs -- particularly
Some money managers are also sifting through the financial sector for dividend payers that can benefit from rising rates. Pomeroy points to
Does turmoil in the energy sector present opportunity for dividend investors? Some managers are watching the sector carefully for opportunities to pick up energy giants on the cheap.
While the shadow of potential dividend cuts hangs over much of the energy sector, investors can still find reliable and attractive dividends in carefully selected master limited partnerships. For more on MLPs, see Income Flows from Energy Partnerships.
Diversifying With Funds
Dividend-focused mutual funds and exchange-traded funds let you scoop up a broad basket of dividend payers. Pay attention to fund fees, which take a bite directly out of the income you'll receive. You'll also need to understand whether the fund pursues a dividend-growth strategy (which may give you a lower yield), a high-dividend-yield strategy (which can mean higher interest-rate risk) or some combination of the two.
The
Another high-quality dividend ETF that Welch likes is Vanguard Dividend Appreciation (VIG), which yields 2.4% and charges fees of 0.10%. The exchange-traded fund tracks an index of stocks that have boosted dividends for at least 10 consecutive years.
Eleanor Laise is Associate Editor of Kiplinger's Retirement Report.