Chasing Dividend Yield for Income: Three Reasons to Be Wary

by Rod Greenshields

Financial advisors use a variety of investment strategies to replace retiree employment salaries or business income.

These include bond ladders, systematic withdrawal programs (SWPs), guaranteed minimum withdrawal benefit (GMWB) products, and even strategies in the relatively new category of target payout funds. But one of the most common approaches is the dividend yield strategy.

Relying on dividends for income is a strategy that has served investors well in the past. Who hasn’t heard of the proverbial elderly widow living off the steady stream of General Electric (GE) dividend checks? And many investors believe that high-dividend-paying stocks are preferable to low- or non-dividend-paying stocks for portfolios intended to meet income needs.

...To continue reading this article you must be registered with AAII.

Gain exclusive access to this article and all of the member benefits and investment education AAII offers.
JOIN TODAY for just $29.
Log in
Already registered with AAII? Login to read the rest of this article.

Register for FREE
to read this article and receive access to future articles.
Rod Greenshields is consulting director of U.S. Private Client Services at Russell Investments.


Brian from Maine posted over 2 years ago:

Assuming stock price appreciation is automatic by internal "beneficial'' company use of retained earnings rather than paying dividends is too simplistic.

Shoshana from Michigan posted over 2 years ago:

Thank you. I found it very educating and quite compelling

J from Texas posted over 2 years ago:

However, dividends are a major source of return when the market is going sideways or down. They also offer some protection.

Larry from Illinois posted over 2 years ago:

very informative thank you.

Thomas from Tennessee posted over 2 years ago:

Over the long term, isn't the majority of stock return due to dividends AND the reinvestment of dividends?

Mike from North Carolina posted over 2 years ago:

The more I read from so-called "expert analysts", the more I am convinced they are almost all just guessing...and guessing poorly at least half the time!!

Scott from Montana posted over 2 years ago:

Total return strategy relies on your having all your wits. Dividend income has a better chance of sustaining those who are less able to make tough analytical decisions.

Robert from Florida posted over 2 years ago:

Your article, for the most part, is simply wrong. If one holds the stock of a company which consistantly raises its dividends over many years price appreciation will necessarily take place or the yields would become astronomical... the market will correct this by increasing the share price.

42 such companies make up the S&P 500 Dividend Aristocrats: companies which have increased their dividends for at least 25 years.

Among these are firms like ABT, ADM, AFL, BDX, CB, EMR, JNJ, KO, MCD, MMM, PG, VFC, and XOM.

Of course buying these Blue Chips does not mean you forego capital appreciation. Nor does it mean that at some point you cannot annuitize all or part of the total or "self annuitize" the portfolio. This is simply done by taking a mortality table and adding 20 years to your predicted life expectancy. (If you are4 65 you may expect to live to about 85, so adding 20 years means you figure on spending the last dollar in this portfolio at age 105. Next make reasonable estimates of portfolio growth and inflation, and plug the numbers into a retirement calculator such as My Calculator.

Prudently selling overvalued stocks as you go, making consideration for taxes, while maintaining your asset allocation, you will be able to collect an amazing amount of money.

Robert from Florida posted over 2 years ago:

Using the above method, let me make a hypothetical example.

Age 65; years to retirement 0;
Portfolio value, $500,000
Length of retirement, 40 years.
Annual portfoli8o increase 7%; inflation 3%.

Annual payment $24,000 in 2011 dollars
Final (40th) payment in 2050, $75,700
Total payout, $1,801,895

If you figure a 30 year retirement (to age 95) then your first annual payment would be about $27,450, and subsequent payments would be the same amount in 2011 dollars, corrected for inflation.

Plug in your own numbers at

Point 1 "There's no free lunch" You are the owner of companies who are good stewards of your property. Rather than spend earnings on executive bonuses and marginal investments, they deliver to their owners on the average 50% of their free cash flow.

Point 2 "Dividends Have Been Declining" Certainly not true for these comapnies, and a large number of other companies with shorter than 25 years, such as "Dividend Achievers". Simply do not buy companies with many years of dividend increases.

Point 3 "Concentration Risk"
That's pure BS. Do these choices look like financial stocks? ABT, ADM, AFL, BDX, CB, EMR, JNJ, KO, MCD, MMM, PG, VFC, XOM. Only AFL and CB fall into that catagory as Insurance Stocks. If you decide to go outside the 42 "Aristocrats" and add some stocks with 'only' 10 years of increasing dividends you can add the "Dividend Achievers" which 1s almost an other 200 companies from all sectors.

I maintain a well balanced portfolio of dividend growth stocksa all with a current yield of 3% or higher, and an average yield much higher.

Jim from California posted over 2 years ago:

When looking for income I usually buy JNK, HYG or PFF ETFs. These typically yield 7-9%.
They have tended to also increase in price as
their dividends decreased. It's easy entry and easy exit.

D from Indiana posted over 2 years ago:

The true gems are stocks such as FDS which have a record of monotonously increasing both earnings and dividends. The catch is that the yield is low and you would have to wit some years to get a decent yield on your initial investment.

Gareth from Minnesota posted over 2 years ago:

I'm not sure why Robert from Florida would say, "Your article, for the most part, is simply wrong." He then goes on to demonstrate using both dividends and capital appreciation to fund retirement, essentially in line with the author's conclusion, "When we consider the risks of a dividend yield strategy discussed above, a total return approach that relies on a combination of dividends and capital gains to fund income-replacement needs is compelling."

I would conclude more strongly than the author that at the end of the day, Total Returns are all that matters. Sure it is nice to have a dividend stream, and the companies that provide consistently increasing dividends tend to be the best run and more profitable.

So I leave you with the question. Would one prefer Robert in Florida's Abbott (ABT) that over the past 5 years has returned 28% including dividends of $7.47 AND capital appreciation, or a stock like Dolby (DLB) or DG FastChannel (DGIT) which pay no dividends but returned 5-year capital appreciation of 115% and 456% respectively? I only chose these companies to make a point. Others would show different results.

Disclosure: I am long ABT, DLB, and DGIT.

Douglas from Oklahoma posted over 2 years ago:

It might depend on which dividend yield criteria is used. If you apply the Weiss dividend yield philosophy you use the high yield as the buy trigger when the other criteria are also met. This results in buy/sell targets that provide approximate capital appreciation on the order of 8-9% with a dividend yield in the order of 2-3 % over the last 20 years (combined about 11%). Well done Robert I think you helped me more than the article did.

E from Georgia posted over 2 years ago:

Apparently Russ is not looking any further than his own nose or perhalps his pocket book. To date I havn't found an advisor or a growth MF for my Small growth port. that can match the total return of my Dividend port. that I manage with limited time. Use advisors only on a pay for performance agreement.

Brian from Florida posted over 2 years ago:

An excellent article. I have drawn from it for use in my MBA Corporate Finance class at the University of Florida. There is a lot in this short article that is not covered in textbook treatments of dividend policy.

jan from California posted over 2 years ago:

This article is really saying don't concentrate ALL of your portfolio in high-dividend equities. What I do personally is put 5% of my portfolio in a dividend-capture fund that pays out monthly. I treat it as sort of money-market account, much better than CDs at banks. The fund itself doesn't move at all, beta 0.29 I calculated. If I am really concerned the fund go bust, I buy a put option on it. Remember, only 5% of my portfolio is this strategy.

Courtland from California posted over 2 years ago:

I disagree about dividends.Over the years they have provided approxximately 40 percent of total return. Also dividend paying stocks historically have outproduced non dividend paying stocks.

George from North Carolina posted over 2 years ago:

The comments provided were as valuable as the article. Thanks to all who contribute.
I put around 7% of my retirement fund in high dividend paying energy Trusts and Limited Partnerships, such as ONEOK.

Andy from California posted over 2 years ago:

The fundamental premise of this article has to be questioned. Yes, yields have declined as a whole but no rational income investor would hold an equity with declining payment. The author provides very little information on what is high yield. Seocond, he seems to overlook a very basic concept namely, yield on cost. He further seems to have based his thinking on a "buy and hold" premise, which again, does not make sense.
Such articles make me wonder what sort of selection criteria were used.

Charles from Colorado posted over 2 years ago:

I also disagree about dividends. It is true that yeilds have decreased, but that doesn't necessary mean the dividend has decreased. I have held XOM for 60yrs. I only recall increases in dividends. The XOM payout is less now than in the past, but of course the price is much higher than in past so the dividend has not decreased.

Walter from Pennsylvania posted over 2 years ago:

As retiree for some 15 years, I have found that a combination of a cost efficient muni bond fund via Vanguard, two hy bond funds and foreign bond exposure, high dividend paying stocks and mutual funds have allowed me to not only derive sufficient income but to grow my porfolio from the surplus and reinvesting that I have been able to do. If a particular stock or fund begins to faulter, I move on to another investment or increase monies from its sale to one I already have. This does mean frequent monitoring, but my portfolio is greater now that it was during the crash of 2008, and my income as grown dramatically as well. Good luck with your own approach.

Ron from Texas posted over 2 years ago:

I have a good living from my D&I (110K)/yr. You have to do your due diligence in buy and trading these stocks. I average a 5.6% yield and all my divident stocks. Last year I made over 100K just buying and selling and rebuying these stocks. If you will spend just a little time and research you can do it too.

Robert from Illinois posted over 2 years ago:

OK, so you have done a good job explaining what is not a good idea. But what is a good idea for income? Are there any good ideas about income replacement that involves dividends? Perhaps your knowledge base says no! This could mean that your knowledge base is deficient. See "Dividend Growth Investing" which is a book on how to choose dividends that avoid all of the "badies" in your article.

Stephen from Florida posted over 2 years ago:

Stock dividends are part of overall investment risk, i.e.reduction or elimination...monitor the payout/per share earnings ratio and determine what rate is acceptable for individual tolerance...This approach has worked for our family for years...

Conrad from Wisconsin posted over 2 years ago:

A $50 stock pays a 3% dividend today. If the share value drops to $25 tomorrow, the dividend increases to 6%. The stock has lost
half its value, but the dividend looks great.
There are many examples of this abounding. I am not impressed with this math providing income!

Don from Texas posted over 2 years ago:

I agree with David. There are several studies that contradict the Russell attitude. In addition you have restricted yourself to the U.S. Since we are global take a look at global stocks where dividends are more "normal". In a decade of negative returns and bleak prospects give me stocks with dividends and appropriate diversification.

Henry from Virginia posted over 2 years ago:

Vanguard Dividend Growth VDIGX managed to survive the recession better than most, and it has maintained a relatively small allocation to finance companies the past few years. Only 47 high quality stocks at present. Current SEC Dividend 2.27. Aims for dividend growwh plus some appreciation. As one a couple years from retirement, I am likely to move more of my stock portfolio to this fund over the next few years.

Paul from Maryland posted over 2 years ago:

I have read several reports that take the opposite approach. Dividends are a sign of strength as long as they are a minor part of a company's profits. If the stock market is static or falling, dividends may well be the only bright light for investors.

Clifford from Pennsylvania posted over 2 years ago:

Good article.

Stephen Smith from Michigan posted about 1 year ago:

The best part of this article was understand the business you are investing in.
I have 3 classes of investments:
1. Dividends
2. Growth
3. Cash

With the fisical Cliff comming I now have more in Cash than ever.

Also good hospitalization coverage will protect your portfolio.
I have a high deductible plan with an underlying supplement funded with cash.

I don't need to touch the dividend or growth buckets for about 10 years

Mark Race from Ohio posted about 1 year ago:

WebMaster, How about updating the comments to this article? Comments that are a year old are for the most part no longer relevant.

You need to log in as a registered AAII user before commenting.
Create an account

Log In