Question:
What do you think of the dividend mutual funds Vanguard Dividend Appreciation ETF (NYSE: VIG) and SPDR S&P Dividend ETF (NYSE: SDY), as opposed to buying individual high paying individual dividend stocks? Also, please name five to six dividend-paying stocks that you recommend.
Answer:
There is generally nothing wrong in buying mutual funds for dividend yields; however, there are reasons we do not suggest doing so. Two main reasons are that as an investor: You cannot control the amount they pay in dividends, and you also cannot control the amount of risk they incur to increase dividends. Like bond funds, mutual funds that seek to increase dividend yield may take on increased risk to achieve their goal. Mutual funds will also try to enhance dividend yield by leveraging or borrowing to invest.
We feel the best route to take would be to invest in individual common stocks that pay a dividend. One reason is that you control what you buy. For example, if you buy Johnson & Johnson (NYSE: JNJ) you will know at what price and the growth factor you locked in. If you were dollar cost averaging into the market every month, you would be able to go through your list of stocks you were interested in and pick the best buy at the time. If McDonald’s Corporation (NYSE: MCD) were to have bad month in the market and the price was down 5%, you could buy McDonald’s that month. Maybe next month, V.F. Corporation (NYSE: VFC) would be down, so you could buy that. Both of those companies pay a healthy dividend, and if you buy individual stocks you can control when you buy them.
Alternatively, if you own a mutual fund, the fund manager could decide that VFC would not do well in the future, and sell the position. You then might be hit with a capital gain. When you own individual stocks, you can control your capital gains.
Currently, VIG pays a little more than 2%, which is not that good in our opinion. SDY pays about 3.3%, which we think is pretty good, but there are several individual high-yield common stocks available right now. In the Consumer Discretionary sector, Leggett & Platt, Inc (NYSE: LEG) yields 5.08% and Altria Group, Inc. (NYSE: MO) is paying 6.29%; in the Energy sector, Royal Dutch Shell plc ADR (NYSE: RDS.A) pays 5.39%; in Healthcare, Glaxo SmithKline plc ADR (NYSE: GSK) pays 5.75%; in the Financial sector, Cincinnati Financial (NASDAQ: CINF) pays 5.19%; in Telecommunications, CenturyLink, Inc. (NYSE: CTL) pays 6.61%, Verizon Communications, Inc (NYSE: VZ) pays 6.03%, and in Utilities, Southern Company (NYSE: SO) pays 4.76%. These are all healthy companies that have paid consistent dividends. However, past performance is not a guarantee of future results. We hold all of these companies in our High Yield Income Portfolio or Dividend Growth Income Portfolio.
We see the interest in dividend mutual funds as an example of consumers doing the opposite of what they should be doing. We look back at the 1990s, at the top of the dot-com era. We could not pry stocks out of clients’ hands to buy a 10-year bond yielding 8%. While we did it, it was difficult to do. Now today, we hear investors say that they are too scared to own stocks, and they would rather buy a 10-year Treasury yielding 2%. The reality is that dividend paying stocks are a way to boost your return with relatively less risk.
We have a client who insisted we sell in 2008 when the market was about half way down. Near the bottom he would not buy. Now today, he is ready to get back into the market, but he has missed a 45% to 50% recovery, not to mention 45% to 50% of his portfolio was sitting in cash, doing nothing. Our best suggestion is to stick with your strategy. If you are a short-term holder, stay short-term. If you are in a long-term strategy, stay long-term. Investors will inevitably get into trouble when they begin changing their strategy.
In our opinion, the riskiest investment today is a 30-year Treasury—not because it will not pay the interest, but because of the interest rate risk. The good thing about individual common stocks is that you can have a stock paying a 3% dividend, but the stock itself is growing at 8% to 10% annually. Even if the company does not raise their dividend in 12 years you could be making 12% from this stock. This is equal to the long-term average for the stock market.
For example, if you purchased McDonald’s in 1990 for roughly $7 a share, split adjusted, it is now paying $2.44 annually in dividends. That is a 35% annual return at cost on dividends alone. While we do not advocate reinvesting dividends in to the stock market, we have seen portfolios where investors do, and years later they have a very sizeable portfolio.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
