Dividend-paying stocks gain momentum
By Meg Richards
Associated Press
NEW YORK — During the bull market, investors hardly took notice of the ho-hum performance of dividend-paying stocks, but they're back in vogue thanks to a favorable tax rate, decelerating corporate earnings and sluggish bond yields.
Compared with open-end index funds, ETFs have a number of advantages: • Unlike mutual fund shares, which are priced at the end of each day, ETFs can be bought or sold at anytime during the trading day at the market price. • Expense ratios are low, relative to regular index funds, and tend to get lower as ETFs grow in size. • EFTs tend to minimize capital gains taxes compared with other types of mutual funds.
Reflecting the interest of income-minded investors, the number of mutual funds focused on dividend-paying stocks has grown from 54 in 1999 to 81 last year, according to fund tracker Lipper Inc., and their assets are on the rise, as well.
About exchange-traded funds
Part of the attraction is their conservative nature, said Jeff Tjornehoj, research analyst at Lipper Inc. Equity income funds tend to lag during growth rallies, but hold up well in downturns, which is appealing to investors focused on preserving what they've saved.
"The companies in these portfolios are not the market's barn burners," Tjornehoj said.
"They're the steady Eddies of the market. But they do tend to appreciate, so people like that ... and when times get tough, they count on that income stream."
Dull though they may be, there's a lot to like about dividend-paying stocks, said John Nichol, senior portfolio manager at Federated Investors. Historically, dividends have made up a significant share of total return; long-term studies dating back to the 1920s show dividends account for about 42 percent of total return on an annualized basis, he said.
"Dividends matter," Nichol declared. "Over the '90s and recently that number has been less, but that focus is changing."
In addition, dividend payers have outperformed nondividend paying stocks over the long run, according to a study by Ned Davis Research. From 1972 to 2004, dividend-paying stocks rose 10.2 percent on an annualized basis, while nondividend stocks rose just 4.4 percent.
Adding to their appeal, a 2003 change to the tax code cut the maximum tax on dividend payments to 15 percent. Some on Wall Street think there's a good chance that will be made permanent during the second Bush administration.
As with all securities, investors should be wary about fees when shopping for equity income funds. The premium paid for active management can diminish or erase the yield — especially if you wind up buying a front-loaded fund through a broker. Decent yields at lower expenses can often be found through index mutual funds or exchange-traded funds, such as the iShares Dow Jones Select Dividend Index, which trades under the ticker symbol DVY.
Darwin K. Abrahamson, chief executive of Invest n Retire LLC in Portland, Ore., which provides Web-based services for 401(k) plans, said he recently transferred a portion of his mother's portfolio to ETFs, including the Dow Jones Select Dividend Index, which pays a 3.11 percent yield and has a rock-bottom expense ratio of 0.40 percent. Previously, her retirement portfolio had been concentrated in loaded funds selected by her broker.
"When I moved her over to ETFs, the first thing he told me was, 'You know, I'm not making much money off these.' And I said, 'Hey, we're not doing this for your back pocket!' " Abrahamson said.
"She was looking for some income, and it (DVY) paid a higher dividend yield than short-term bonds or money market accounts, but still had upside growth potential. And retirees are living so long these days, they can't just go strictly on income. They still need that growth."
The combination of current income with capital appreciation can be a compelling draw. Still, yields among open-end mutual funds that focus on dividend-paying stocks tend to be somewhat limited, usually in the 1.5 percent to 2 percent range.
Decent yields at lower fees can also be found through index funds and ETFs that focus on sectors known for paying dividends. The iShares Dow Jones U.S. Financial Sector (IYF) yields 1.75 percent, while the utility index (IDU) yields 2.83 percent; both charge expenses of 0.60 percent. The Utilities Select Sector SPDR (XLU) yields 3.14 percent and charges a 0.27 percent expense ratio. The Vanguard Utilities VIPER (VPU) is another good option, yielding 3.16 percent. Income can also be derived from ETFs that hold real estate investment trusts, such as the new Vanguard VIPERS REIT (VNQ).
