Remember risk when chasing dividends
Q: If you had $1,000 to invest toward retirement, would you put it all in shares of Coca-cola and Bank of America for the dividends or just buy a diversified ETF?
A: People have been searching for the Loch Ness Monster for decades. Lately, it seems people are more likely to find traces of that mystical beast than locating investments that generate a decent yield.
Given that interest rates have been so low for so long, investors looking to actually live off their investments continue to struggle. Some are looking far and wide for any kind of asset that might throw off any semblance of cash flow, ranging from master limited partnerships to mortgage bonds and corporate bonds. Another strategy to find income is through buying common stock of high-dividend paying companies. Investors are betting that thanks to record corporate profits and relatively inexpensive stock prices, they can get decent yields by owning just the right stocks. Plus, unlike bonds that pay fixed levels of interest, companies’ dividends can very well rise over time.
It sounds like this is your strategy and that Coca-cola and Bank of America are the two stocks on your short list. Does it make sense to load up on these two stocks, concentrating your investment bet with the goal of hitting bigger dividends?
To find out, let’s first examine what the two stocks are currently paying in terms of a dividend yield. Coca-cola is yielding 2.7%, and Bank of America is yielding a mere 0.7%. Bank of America has only been paying a cent a share as a dividend since the first quarter of 2009.
Combining the two dividend yields, you would get an average of 1.7%
However, at the same time you could simply invest in the Standard & Poor’s 500 index. This index comprises 500 stocks, including Coca-cola and Bank of America. You also get a higher divi- dend yield. The yield on the Vanguard S&P 500 exchange-traded fund is 1.9%, which is bigger than the one paid by the two stocks you suggest.
Meanwhile, by owning an additional 498 stocks, you get more protection against stock price volatility. If Bank of America were to run into more financial trouble, your investment could be hedged through the diversity of owning not only other banks but shares of companies in many other industries.
If dividends are that important to you, you can get an even higher dividend yield by investing in an ETF that focused only on stocks with large yields. For instance, the Vanguard Dividend Appreciation ETF pays 2.1% annually as a yield and is likely to increase in the future.
Investors’ desire for dividends is completely understandable. After all, with interest rates near historic lows, it’s getting harder to find income.
But by loading up on just two stocks, including one that pays a lower dividend than the S&P 500 index, you’ll get less income and more risk compared with other options.