Investors disagree on whether the long-running bull market, which caught its second wind with the so-called Trump bump, will continue to power on. According to surveys, professional investors remain fairly bullish, but many on Main Street don’t trust this particular animal. And with recent economic indicators showing somewhat tepid growth here at home, and geopolitical worries and the shenanigans of the president himself taking a toll, it’s hard to know whether to plan for an imminent pullback or continued interest rate hikes.

Luckily, dividend-paying stocks offer strategies for both scenarios.

Dividend payers have always been popular—the classic image is the retiree who buys household names such as General Electric and Coca-Cola with the intention of “living off” the steady income that dividend payments provide. Moreover, companies that have a history of dividend increases also tend to outperform the broader stock universe. The S&P Dividend Aristocrats Index—which includes only companies that have raised their payments on common shares for at least 25 years—has consistently outperformed the S&P 500, returning 10.7% over 10 years while the latter returned 7.5%. Add to that the phenomenon of certain types of dividend-paying stocks gaining additional appeal as bond proxies in the low-interest-rate environment of recent years, and you’ve got quite a few investors at the party.

This popularity, however, doesn’t mean all dividend-paying stocks are created equally—even those in the “aristocrat” category—and advisors should take care to keep their clients’ expectations in check. Dividends do get cut.

“People buy these stocks for the income, but they need to understand that a dividend is not contractual, it’s not like a bond,” says Scott Davis, lead portfolio manager on the Columbia Dividend Income Fund at Columbia Threadneedle Investments in Boston. “The dividend itself doesn’t create value. What creates value is a corporation with strong cash flow that can return cash to shareholders.”

For example, during the volatile energy market of 2015, Houston-based pipeline giant Kinder Morgan slashed its dividend by 75%. The move, brought on by the severe downturn in the industry after oil prices tanked, was expected by the time it happened but still represented a shocking turnabout for a company that had promised ever-rising payouts to shareholders.

When it comes to dividend investing and market conditions, generally speaking you have two overarching strategies: yield and growth. The former tends to do better in down markets, while the latter outperforms in bull markets, and there are plenty of both active and passive funds to choose from in both categories. Yield investors seek out the companies that pay the highest dividend per share—popular funds of this sort include the Vanguard High Dividend Yield Index Fund and the Fidelity Equity-Income Fund. Growth investors, meanwhile, prefer to see steady dividend increases. The T. Rowe Price Dividend Growth Fund and the ProShares S&P Dividend Aristocrats Fund represent a couple of well-liked options in this category.

The low-interest-rate environment of recent years—even after the Fed’s recent increase, the 10-year Treasury still hovers around 2.20%—has driven many folks into the high-yield category. Retirees especially, who need that steady income, have taken to using high yielding dividend funds as a proxy for bonds. “If you want to keep pace with inflation, you can’t do it with the old school conservative stuff like CDs and bonds; you have to step into equities,” says Robert Laura, president of SYNERGOS Financial Group, a registered fee-based advisor in Michigan. “And there are a lot of people who’ve needed to step in.”

The high-yielding dividend strategy can work well if a recession hits, because many of these companies tend to come from recession-proof industries such as utilities and telecoms. For example, Southern Company pays a 4.45% dividend yield a year, and AT&T pays 5%. (The average large-cap stock pays a 2% dividend yield.)

However, if you’re looking for overall total return, dividend growth companies—generally from sectors like financials, industrials and technology—will outperform high-yield payers. Case in point, tech giant Apple, the largest company by market cap in the world, pays a dividend yield of only 1.72%, but the company has been growing its dividend at a much more significant rate than your typical high yielder. In May, Apple announced a 10.5% increase to its dividend.

Ann Marie Etergino, a financial advisor with RBC Wealth Management in Chevy Chase, Md., says the client who wants high dividends with the idea of living off the income is less concerned about price appreciation and more concerned about cash flow. For these investors, who tend to be heavily invested in certain sectors, she would typically use active strategies because of concerns about concentration risk. And again, there’s expectation management.
 

“I have one client who wants to live off her income and not her principal,” says Etergino, who caters to a mix of high-net-worth families and nonprofits. “And I’m trying to point out that the most you’re going to generate is 3.5% to 4% because that’s what most high-yielding dividend strategies pay. She thinks she can get 5% to 6%, but you can’t do that prudently and still be growing the assets. … Dividend growers will give you a better total return over time.”

 

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