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Sep 15, 2021 | Investment Management, Q&A

Q&A: What is the role of dividend-paying stocks in a portfolio?

In our last Q&A, we discussed the role of fixed income (or bonds) in a balanced portfolio. Continuing on the topic of balanced portfolios, dividend-paying stocks also play a key role in balanced portfolios, providing sector and industry diversification.

BENEFITS OF DIVIDEND-PAYING STOCKS:

The primary benefit of dividend-paying stocks is an attractive and reliable income stream to the investor. Dividend payments also smooth out the total return of the stock, as a portion of that return is coming from the dividend payment. This becomes especially apparent during economic slowdown and market decline, when the price of the stock falls, but is at least partially offset by the payment of the dividend.

In addition to the benefits mentioned above, dividend-paying stocks enjoy several other key benefits, including:

  • higher level of income and yield compared to savings and checking accounts, CDs, and some fixed income investments
  • dividend “growth” when a company increases its dividend on an annual basis
  • an opportunity for income and long-term capital appreciation
  • stability during periods of high volatility (most produce “needs-based” products such as everyday household goods, electricity, industrial parts., etc. and tend to deliver consistent revenue and earnings through different economic cycles)

In March 2020, during the COVID-19 outbreak, the Federal Reserve cut the Fed Funds Rate to 0.% – 0.25% target rate. Eighteen months later, interest rates remain at these historically low levels. In this low interest rate environment, it can be difficult for investors to find investments that generate an attractive level of income. At the same time, the US Consumer Price Index increased 5.4% over the past 12 months, making it difficult for savers to keep pace with inflation. Dividend-paying stocks play an even more critical role in balanced portfolios in our current low interest rate environment. This is due to their ability to help generate income and provide an opportunity for growth (hedge against inflation over time).

RISKS:

While dividend-paying stocks have many attractive qualities and have historically been less volatile during market downturns than non-dividend paying stocks, they are still equities – and subject to price movements based on economic, market, and geopolitical factors. Unlike bonds, dividend-paying stocks do not have a fixed coupon. Although a rare occurrence in high-quality dividend-paying companies, companies can choose to cut, suspend, or even eliminate their dividend payments if they deem it prudent.

Having a diversified portfolio is important in any economic environment. Your Godsey & Gibb Wealth Management Advisor can work with you to determine the appropriate balance and provide you with additional information on this strategy, and how it can contribute to your long-term goals and objectives.

Author: Kevin Riley | Wealth Management Advisor
Written: September 15, 2021