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24 August 2010
As the economy continues its slow recovery, more and more companies are earning more money, and passing their profits directly on to their shareholders.
How? By increasing their dividends. Simply put, the checks these companies send their shareholders each quarter are getting larger. In the nine months through October of 2010, 745 companies increased their dividends.
Not surprisingly, the news has made many investors change course and flock to this category of stocks. I haven’t had to change course: I have been a big believer in dividend-paying stocks for many years. One of my strengths as a financial adviser is selecting these stocks for my clients’ investment portfolios.
I’m a longstanding fan of dividend-paying stocks because they fit the needs of so many of my clients so well. Stocks that pay regular dividends are excellent investments for retirees, widows and anyone else who needs dependable income.
One of my clients, whom I’ll call Kathy, is a good example of an investor who benefits from owning dividend-paying stocks. Kathy, 35, is a military widow who is raising three young kids and going to school at night. Like many military widows, she can’t take a full-time job because of her responsibilities as a single parent. So she uses income from her investment portfolio to help make ends meet.
Kathy will need income from her investments for many years as she raises the kids—and she also wants something left over for her kids’ college tuition and her retirement. If Kathy’s portfolio were heavy on growth stocks, she might not sleep very well at night. Growth stocks can increase in value quickly, and once they’ve appreciated, they can be sold to provide cash. The catch is that once a recession hits, or their growth momentum fizzles out, they can lose value as quickly as they gained it.
Stock market volatility can shrink a $500,000 portfolio to $400,000 in just a few months—and if, on top of that, an investor needs to sell shares to cover their expenses, the portfolio can wither away fast.
On the other hand, portfolios full of blue-chip, dividend-paying companies might not grow as fast as those that are heavy on growth stocks. But they are extremely reassuring to widows, retirees and others who need to play it safer with their money and who depend on a reliable stream of income.
It’s important to realize that not all dividend-paying stocks are good investments. Many companies try to lure investors by paying dividends that are actually higher than they should be. If you invest in a company that pays a 10% dividend, but only earns half that, you may one day find yourself owning stock in a bankrupt business. On the other hand, there are plenty of high-quality, dividend-paying stocks to choose from.