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Dividend Funds May Calm Investors

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The Associated Press

Published: November 9, 2008

NEW YORK - Wall Street is showing signs of settling down but the economy is still quite troubled, so putting money into funds that focus on dividends might help some investors regain their confidence in the market.

The steady returns of dividends can be attractive when the outlook for corporate profits is murky and interest rates are low, leaving other income-generating investments such as bonds with meager yields. But it's important that investors ask questions before jumping into dividend funds.

First, there is no guarantee that a troubled company won't cut its dividend or that the market will regain its appetite for companies with greater growth potential and less focus on payouts to investors. More important, investors who have seen stocks flattened by the market's yearlong retreat should first consider whether shifting money from one fund to another is wise, or whether that will simply lock in big losses. Making gradual changes can help guard against panicky investment decisions.

For investors looking to shift some holdings or dip their toes into the market, dividend funds can offer some reassurance because the flow of dividends can help make negative returns less severe.
Stocks that pay dividends tend to trade with less volatility, noted Dan Genter, president and chief investment officer of RNC Genter.
Genter noted that some of its funds have declined less than the broader stock market because of the income from dividends. The S&P 500, a benchmark for the stock market and many mutual funds, is down about 35 percent from its October 2007 peak. Genter's dividend funds have lost only half to two-thirds as much as the market, he said.

While the stock market has shown somewhat less nervousness since its mid-October lows, it's unclear how long it might take stocks to recover - recent days have shown there's still plenty of turbulence on Wall Street.

"It is going to reduce your volatility compared to the overall equity market," Genter said, adding that a long-term focus is best, particularly in a bruising market.

"You don't necessarily want to jump over to this because you were looking for a place to hide," he said.

Frank Ingarra, co-portfolio manager at Hennessy Funds, noted that the income can trump what would be coming from other investments. The company employs a so-called "Dogs of the Dow" strategy that involves investing in 10 of the 30 stocks in the Dow Jones industrial average that are out of favor but have the highest dividend yields. The idea is to boost overall returns by capturing a mix of potential gains from increases in share prices and regular dividends.

Ingarra noted that the average dividend yield from investing in "Dog" companies that include General Electric Co., AT&T and Caterpillar is 5.33 percent; that compares to a yield of 4.33 percent for some longer-term government bonds.

"I think for the average investor, this is a great place to start into dividends," he said, pointing to the market's huge decline from its peak and reassurance of getting some income while awaiting a market rebound. And the quiet returns of dividends can help some investors keep pace with inflation more easily than bonds.

Like any investment, dividend funds carry risks. Financial services companies have long been known as big dividend payers. But with so much of the banking sector in turmoil because of bad debt, investors need to consider whether a dividend fund is drawing too much of its income from troubled companies that could be forced to cut their dividends.

And even if a dividend fund looks attractive there are tax considerations. Investors should ask before putting money into a fund whether a payout is imminent. Otherwise a new investor could receive a payout but also a hefty tax bill. It's better to wait until after a payout and then have more time to accumulate income before paying taxes.

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