Dividend Edition: Advantages of Dividend-Paying Stocks

In today’s Dividend Edition, I’d like to share a recent article from Richard J. Moroney’s Dow Theory Forecasts. In it, Moroney explains why dividend-paying stocks are now probably a better investment, even for conservative investors, than bond funds.

“For many investors, holding bonds makes sense. But with high-quality bonds yielding so little today, even conservative income investors should give stocks a look.

“The benchmark Barclays Aggregate Bond Index yields only 1.9%, while the average taxable intermediate-term bond fund pays roughly 2.6%—in line with the average dividend-paying stock in the S&P 500 Index.

“While stocks are more volatile than bonds, they tend to outperform over the long haul. Since 1926, large-cap stocks have delivered an annualized return (including dividends) of nearly 10%, versus less than 6% for intermediate-term government bonds.

“Bonds have outperformed over the last 10 years and continue to receive the bulk of mutual fund inflows, but recent returns could help stock funds win back some fans. Since the start of 2012, the average large-cap blend fund is up 6.2%, versus 4.3% for intermediate-term bond funds. Over the last three years, large-cap blend funds returned an annualized 15.3%, compared to 8.2% for intermediate-term bond funds.

“In addition, dividend-paying stocks tend to deliver less-volatile returns than the average stock. U.S. stock funds with recent yields of at least 2% averaged a three-year annualized standard deviation (a measure of volatility) of 16%. In contrast, funds yielding less than 2% averaged a standard deviation of 19%.

“[We found] 10 attractive income funds from nine different categories, all of which hold more in equities than in bonds. To make the cut, a fund needed to yield more than the average dividend-payer in the S&P 500 and the average intermediate-term bond fund. [Here are two of them]

iShares S&P U.S. Preferred Stock Index (PFF), with a current yield of 6.5%, has returned 12.8% so far in 2012. Preferred stocks often behave more like bonds than stocks because they are sensitive to an issuer’s creditworthiness. The fund, with an expense ratio of 0.48%, has a three-year annualized return of 14.8%.

Vanguard Wellington (VWELX) is a longtime Forecasts favorite and a holding in our recommended Growth and Conservative portfolios. The fund, which holds roughly 60% stocks and 40% bonds, yields 2.6%. Its 10-year annualized return of 7.3% ranks among the top 6% of its peer group. The expense ratio is 0.27%.” —Richard J. Moroney, Dow Theory Forecasts, July 16, 2012

The Vanguard Wellington fund was also recommended in the Dividend Digest recently, by Richard C. Young, Editor of Young’s Intelligence Report, who wrote:

“When you consider what fund to buy, you should keep a few core principles in mind. Among them should be risk, expense, income and diversification. The Vanguard Wellington Fund scores high marks in all four categories. With a history that dates back to 1929, the Wellington Fund is one of the nation’s oldest and most successful mutual funds. Wellington has successfully navigated through eight decades of financial market turbulence, including the Great Depression, the stagflationary 1970s and the more recent credit crisis. The fund’s success lies in its balanced investment strategy. To reduce risk, Wellington invests about 60% of its assets in stocks and the remaining 40% in bonds.

“From its 1929 inception, Wellington has earned a compound annual return of 8.18%—enough to turn a $5,000 initial investment into $3.4 million. A low expense ratio of only 0.27% has also contributed to Wellington’s success. Similar funds average an expense ratio of 1%. It is astonishing how many mutual fund investors ignore cost. Cost is the best predictor of long-term mutual fund returns. Low expense ratio funds tend to earn above- average returns while high expense ratio funds often earn below-average returns. Vanguard calculates that the cost difference between the Wellington Fund and a typical balanced fund could save a Wellington investor around 17.5% over a 10-year period. Not a small sum.

“The fund’s current yield is [almost] 3%, almost a full point above what the S&P 500 is paying, with less risk. In today’s yield-starved environment, 3% on a low-risk portfolio of stocks and bonds with a low expense ratio is an attractive buy. I encourage investors who are retired or soon to be retired to focus—laser-like—on generating income in their portfolios. … Wellington is suitable for all investors, as it can be used as a core holding for investors in their 30s or 40s. Rely on the mix of 60% stocks and 40% bonds to smooth out the volatile swings in the market, but to still provide meaningful returns.” —Richard C. Young, Richard C. Young’s Intelligence Report, May, 2012

In addition, VWELX makes distributions every month, so holders enjoy a constant trickle of income into their accounts. It’s definitely a good choice for investors looking to add some income and stability to their portfolio.

Wishing you success in your investing and beyond,

Chloe Lutts

Editor of Dick Davis Investment of the Week

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