Dividends Give Stocks’ Risk a Buffer

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Photo Credit: Nicholson Cartoons

Though investors may love dividends for their income potential, stocks that issue dividends to investors also fair better in weaker markets.

What’s In a Dividend?

Dividend paying stocks are more than just income producers; they’re also wealth protectors.  Because dividend stocks pay out a dividend regardless of the performance of their stock price, they’re very much protected to the downside.  Consider the idea that fixed income investors can reroute investments to high yielding dividend stocks when the yields become attractive.  As such, dividend stocks are less likely to dip in price when the yield coincides with yields on corporate debt.  Higher yields mean a smaller chance a stock is going to zero.  Wouldn’t we all invest $10 for a stock yielding $.75, especially one that is financially sound?  Of course we would!

Dividends Over Bonds

Triple A rated firms may offer higher yields to holders of their corporate debt, but be wary of the downsides.  With rates at their lowest in history, the chance that interest rates will rise is almost a certainty.  When rates rise, the value of bonds dip, exposing investors to a paper loss until maturity, when the full face value of the bond is paid to investors.

Dividend stocks, on the other hand, do not have such certain downside, and for investors with less time on their hands, they present a very attractive opportunity.

The bottom line is that dividend stocks have a potential to the upside and minimal downside possibilities, while bonds are almost certainly headed to the downside in the foreseeable future.  With that in mind, it makes perfect sense to start allocating more of your fixed income allotment into stocks, but not just any stock: only high yielding dividend stocks.

Be Smart About Your Selection

If you’re nearing retirement, it makes little sense to start shifting large sums of capital out of fixed income and into dividend stocks.  Since there is generally more volatility and risk in stocks compared to fixed income, it would be best to stay where you are.

However, those with long term horizons have plenty of extra flexibility by proper employment of high yield stocks within a retirement portfolio.  For twenty and thirty year olds, ditch the debt and buy stocks; you’ll have plenty of time to make up the difference should losses occur.  However, with dividends as rewarding as they are now, you can even afford some capital depreciation.

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