BONUS TIP – Dividend paying stocks are NOT substitutes for bonds
Over the years, investors’ attachment to dividends has swung from being the Holy Grail to the worst use of capital in the markets. And that typically depends on how well or poorly the stock market did the previous year or two. In the late 1990s, dividend investors were laughed at as “out of touch” and “very old school” while the dotcom mania was in full swing. Yet after a challenging 2011, high paying, quality dividend investments are all the rage.
What is most concerning is that investors who traditionally bought high quality corporate or municipal bonds or similar fixed income instruments are now using dividend stocks as substitutes. Any time we have seen risk averse investors throw caution to the wind for better returns, it usually ends in misery and disaster.
If an investor buys a bond that does not default and holds until maturity, he or she receives par or one hundred cents on the dollar. The bond may fluctuate in between the purchase and maturity time, but the amount received is known. If an investor buys some top notch stocks that pay handsome dividends, not only does that stock’s price fluctuate, sometimes wildly, but the sale price can be substantially higher or lower than the purchase price. That exposes the investor to the possibility of significant loss of the amount invested. Just look back to 2008 to see the utter destruction some of these high paying dividend stocks saw during the crisis. While there are some very good benefits to high quality, dividend stock investing, it is certainly not a substitute for old fashioned corporate and municipal bond buying.
