It certainly has been a lousy time to be a dividend investor. Indeed, sectors that have historically been popular with dividend investors, such as financials and real estate investment trusts, have been some of the hardest hit groups over the last 18 months.
And plummeting stock prices are only part of the pain. More than 40 companies in the S&P 500 have cut their dividend payouts this year–a total reduction of roughly $41 billion a year in cash lost to shareholders. That amount is greater than the total dollars in lost dividends for all of 2008–a historically lousy year for dividends!
Moreover, things are not likely to get better anytime soon. Weak corporate profits and fragile balance sheets will continue to pinch dividends. And with so many companies cutting or omitting them, the stigma attached to a dividend cut has all but disappeared. Don’t be surprised to see more companies trimming their payouts.
Yet, despite all the bad news surrounding dividends, one important point remains: Many of your clients don’t just want dividends; they need them.
Every day in this country, more than 10,000 people turn 60. My guess is that these aging boomers represent your typical client. And increasingly, these clients are demanding two things from their investments: cash flow and safety.
One could argue that there has never been a better time to look for attractive, dividend-paying stocks. Massive stock declines over the last 12 months have boosted dividend yields to their highest levels in many years. The current yield on the S&P 500 Index as of March 31 was more than 3% versus the roughly 2.6% yield on 10-year Treasuries. You’d have to go back to 1958 for the last time stocks as a group had a higher yield than 10-year Treasuries!
Yield-starved clients have few options for generating needed cash flow. Many bond sectors have been almost as dicey as stocks. Like long-term Treasuries, most bank CDs offer paltry yields below 3%; and the yields on short-term Treasuries, money markets and brokerage sweep accounts are approaching zero. Your clients may have been willing to accept virtually no yield for fear of further declines in the stock market, but that sort of risk aversion is not sustainable. At some point, they will demand higher yields.
But if 2008 and 2009 have proved anything, it’s that simply picking “marquee” stocks with decent yields is a potentially dangerous approach. Given the number of widely held stocks that have cut their dividends (can you say G-E?), chances are pretty good that your clients held one or several of them. And you don’t want to go through that again.
In fact, from an advisor perspective, there’s probably little upside for dividend-focused clients to own individual stocks, and plenty of grief should the companies cut their dividends. A better approach is to invest in a basket of dividend payers providing needed diversification while limiting the impact–not to mention client ire–of a dividend cut in one of the holdings.
As the table shows, there is no shortage of ETFs bearing attractive yields. But because lots of high-yielding ETFs held lots of financials, many of them were not exactly stellar performers over the past year. When financials got crushed, so did the ETFs, so understanding sector exposure is important in analyzing which ETF makes the most sense for your clients.
Another consideration is whether the ETF’s yield provides a valid indication of the expected cash flows it will distribute to your clients. To that end, I purposely omitted from the table ETFs that invest in REITs. That may surprise some of you since REITs are typically a favored hunting ground for dividend-hungry investors. However, when it comes to dividends, REITs present a special problem this year. Admittedly, I’m not a fan of real estate investment trusts. I don’t like the fact that REIT dividends usually don’t receive the preferential 15% tax rate. And the dependency of REITs on the potentially volatile commercial and industrial real estate markets is a concern. But the troubling issues that have surfaced over the last 12 months go beyond weak price performance. In fact, in some respects, REIT cash dividends are becoming an endangered species.
According to data compiled by BMO Capital Markets, roughly 30% of all listed REITs negatively altered their dividend policies within the past year. And in a new twist on “sticking” it to shareholders, a growing number of REITs are paying part of their dividend in company stock.