Putting money into funds that focus on dividends might help some investors regain their confidence in the market. But it's important that investors ask a few questions before simply jumping into dividend funds.
NEW YORK — 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 when interest rates are low, leaving other income-generating investments like bonds with meager yields. But it’s important that investors ask a few questions before simply jumping into dividend funds.
First, there is no guarantee that a troubled company won’t cut its dividend.
Study before you leap
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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 dip their toes into the market, dividend funds can offer some reassurance because even when share prices fall, the flow of dividends can help make negative returns less severe.
Stocks that pay dividends tend to trade with less volatility because of the financial discipline required to meet recurring payments and the more mature nature of their businesses, 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.
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, 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.
Funds carry risks
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.