High Dividend Strategies Are Not The Same
Comprehensive studies have highlighted the advantages provided by holding stocks with high dividend yields over extended periods, often at least a few years. High dividend yields go hand in hand with low valuations, so this approach would seem to make a lot of sense. But there’s a lot more to the strategy than just buying the highest yielders and then waiting for the payoff.
A closer look is essential. One example is companies that don’t have sufficient profits to support their dividends. Sometimes that suggests the possibility of a dividend cut or elimination, which means the high dividend yield is about to be reduced or disappear. On a few occasions, when the earnings shortfall is not likely to persist, the dividend may be maintained.
Another concern is stocks that always have high yields and low valuations simply because the growth rates of the companies are modest or erratic. Whether it’s slow growth, erratic progress or uncertainty about where companies are headed, investors won’t pay up.
The element that gives the high dividend yield stocks the edge is the occasional surprise that company profits have been significantly better than expected. When that happens, their prices often jump. The flip side, for stocks with low dividend yields and high valuations, is the likelihood that investors will bail out when there are disappointments.
However one approaches the high dividend yield strategy, it’s important to remember that the longstanding advantages it provides depend on buying a widely spread group of these stocks. This can be done through a variety of strategies available through exchange-traded funds. The best-known of these funds are:
SPDR S&P Dividend ETF (SDY)
iShares Select Dividend ETF (DVY)
Amplify CWP Enhanced Dividend Income ETF (DIVO)
WisdomTree U.S. Quality Dividend Growth ETF (DGRW)
Vanguard Dividend Appreciation Index Fund ETF (VIG)
SDY invests in companies that have consistently increased dividends every year for at least 20 consecutive years. DVY is less specific, focusing on the highest-yielding stocks in the S&P Index.
DGRW differs slightly in that it includes high dividend paying U.S. common stocks with growth characteristics.
DIVO is quite different. It invests in dividend-paying U.S. stocks along with an options strategy to reduce volatility and boost returns.
Then there’s VIG, which is a hybrid version of the high dividend yield strategy. VIG includes a broad group of stocks in the Standard & Poor’s 500 Index that have a history of increasing dividends over time, the length of which is not specified. This ETF turns out to have a far larger number of dividend yielding stocks so it ends up somewhere between a high dividend yield ETF and a typical S&P 500 index fund.
What’s important to remember is that although the high dividend approach has had good results over long periods, its returns are anything but assured in every single year. Indeed, there have been multiyear spans when it came up far short.
N. Russell Wayne, CFP®
Sound Asset Management Inc.
Weston, CT 06883