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Sound Advice: November 30, 2022

High Dividend Yield Strategy? Yes, But!

When times are tough, there always seems to be increasing talk about the high dividend yield strategy.  It’s an approach that, if implemented properly, produces better than average returns over time relative to the level of risk accepted by the investor.  Although these stocks will usually underperform in strong markets, their resistance to price erosion in weak markets is what gives them the edge.

Over extended periods of three to five years or more, portfolios that include a broad selection of high dividend yield stocks will usually be good choices.  One of the keys is the phrase “broad selection”, at least a dozen if not twice that many.

The analysis of individual high dividend yielding stocks begins with a comparison of company earnings and dividends paid.  That’s known as the payout ratio.  If dividends paid are well covered by company earnings and are likely to continue being well covered, that’s a good sign.  But, especially with cyclical companies such as the construction industry, the earnings pattern tends to be choppy and there may well be times when the companies’ profits fall short of what’s being paid as dividends to investors.  Some of these companies are very well financed, enabling them to maintain their payouts.  Others have no choice but to eliminate their dividends.

In those cases, an apparently generous dividend yield, which might be in the high single digits, could be misleading when more challenging times lie ahead.  A further problem is that when dividends are stopped, funds holdings stocks with high dividend yields have to sell their holdings.

The common routes for those seeking high dividend yield holdings are open-end mutual funds and exchange-traded funds.  There is a wide selection available and, in most cases, with expense ratios that are quite reasonable.  Some emphasize the longevity of dividend payments.  Others focus on the growth rate of dividends.  And then there are those that credit consistency of dividend increases over extended periods.

Investors who prefer a simplistic approach to portfolio construction could certainly include one of these high dividend yield funds as the domestic equity component of their holdings, possibly supplemented by a high dividend yield international fund.  As we move ahead through the current economic cycle and interest rates rise further, the addition of a total bond market fund should also be considered.

N. Russell Wayne, CFPÒ

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