Dividend stocks have been highly fashionable lately, and for understandable reasons. The Federal Reserve is keeping rates low and punishing savers. That has pushed more investors into equities … but low-risk strategies tend to focus on the low volatility and high income potential of dividend stocks instead of aggressive bets in growthy technology companies or emerging markets.
There are a lot of benefits to be had from a good dividend stock strategy in your portfolio. Still, I remain convinced that there is a fundamental misunderstanding among many investors that dividend stocks are inherently safe.
They are not.
I recently joined Moe Ansari, host of the nationally syndicated radio show Market Wrap with Moe, to discuss some of the risks facing dividend stock investors.
The three biggies I see are:
Low Volatility Works Both Ways: Last year, the stock market went like gangbusters with 30% gains for the major indices. However, dividend stock funds such as Vanguard Dividend Appreciation ETF (VIG) or the T. Rowe Price Dividend Growth Fund (PRDGX) slightly underperformed. Tom Huber, portfolio manager for the T. Rowe fund, explains why: “You should outperform in choppier, lower-return markets, but you’re not as likely to participate fully on the upside in strong markets.”
Low Volatility Doesn’t Mean Low Risk: Even worse than broad-based dividend funds has been the performance of the Utilities SPDR (XLU), an ETF that focuses wholly on stocks in the utility sector and thus tends to be chock full of dividend stocks. In 2013, the fund was up a measly 13% including dividends vs. the 32% gain for the broader stock market — and one of the biggest dividends stocks out there, utility leader Southern Co. (SO), barely finished flat (including its hefty dividend). There is no such thing as a “risk-free” investment, and even low-volatility dividend stocks carry their own flavor of risk.
A High Dividend Doesn’t Always Mean You’ll Get a High Return: There’s an old joke among investors who chase yield: The easiest way for a stock to see its dividend yield double is to watch its share price get cut in half overnight. Take retailer Coach (COH), a big consumer brand with a big dividend yield of 3.3% … and a 12-month performance of -30%. Or oil services stock Transocean (RIG), which yields more than 7% but has lost about 17% since January alone.
Check out the full audio of the interview here.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at firstname.lastname@example.org or follow him on Twitter via@JeffReevesIP.