Morningstar Advisor - October/November 2011 - (Page 34)

Spotlight The Virtues of Dividends By Josh Peters In today’s conditions, high-payout stocks have the ability to offer something cash, money markets, and bonds can’t: real return. Every time interest rates drop or a recession threatens, dividend investing invariably gains in popularity. I’ve seen more than a few of these cycles since 2005, when I became the founding editor of Morningstar DividendInvestor newsletter. I’ve seen even more since my career as a personal investor began with the purchase of eight shares of Minnesota Power & Light (now ALLETE ALE) in 1990. To think that a routine, low-risk utility selection yielded nearly 8% back then! But we’re in no ordinary cycle, and dividends are no mere fad. Long-term investors of nearly all stripes are grappling with a singular problem: how to preserve the purchasing power of our capital and wring some positive returns out of an environment that seems determined to rob savers and risk-averse investors of fair treatment. Exhibit 1 illustrates the challenge; the real return on so-called “risk-free” investments (I use a one-year Treasury bill as a proxy) is now sharply negative. Today, avoiding risk, at least in the usual sense of the word, all but guarantees loss. Dividend-paying stocks may not be the solution for every aspect of this challenge. For starters, dividends are all but worthless for short-term traders. The best high-yielding stocks in today’s environment might yield 6%, but given the volatility to which all stock prices are prone (even dividend payers), a year’s worth of dividends could be lost in minutes. High-yielding stocks are also a poor substitute for cash or short-term bonds in an investor’s financial safety net. The common stock of AT&T T does yield a lot more than you can get from the bank down the street, but AT&T doesn’t guarantee your original principal back the way a certificate of deposit does. And I cringe to think that investors—including a lot of institutions—are climbing aboard the dividend bandwagon with an eye to merely “lose less” than the leading benchmarks. That being said, we’re in an environment where super low returns all but force investors to embrace some kind of risk, which in turn raises the question of which risks are worth taking. For serious long-term investing, high-payout stocks are far better positioned than cash, long-term bonds, and stocks with low or no dividend yield. They may even be the only way to get a decent real return. A Real Challenge risk-free, near-cash investments, such as money market funds, short-term bonds, and certificates of deposit. In the 12 months through July, consumer price inflation ran at 3.6%. With one-year Treasury bills furnishing a return of only about 0.2%, their holders have suffered a 3.4% loss of purchasing power. Worse, the pace of inflation—at least until very recently— has been accelerating: Earlier this year, inflation was running at an annualized rate of 5% to 6%. By itself, this rate would be cause for some concern, but because interest rates have not risen in tandem with inflation, the purchasing power of cashlike investments is falling at an unusually steep rate. This situation makes the Federal Reserve’s monetary policy statement on Aug. 9 all the more extraordinary. With one hand, the Fed threw the economic recovery under the bus; with the other, it very nearly promised to hold short-term interest rates to near zero for another two years. So, there we have it: no growth, no yield, and rising inflation. It’s hard to think of a worse hand that investors could be dealt. Bill Gross of PIMCO says that this lamentable situation is actually a key objective of U.S. monetary policy. He believes that the Federal Reserve is determined to hold short-term interest rates below the rate of inflation for perhaps 15 or 20 years to come. In his view, Although I make a practice of keeping DividendInvestor’s model portfolios fully invested (or nearly so), I have a lot of respect for cash. Ordinarily, it won’t earn much of a return, but it always trades at par, it comes in handy during a crisis, and, in prudent hands, cash can have extra value by being ready for attractive opportunities that come along. Yet cash is being trashed—and so are all 34 Morningstar Advisor October/November 2011

Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2011

Morningstar Advisor - October/November 2011
Contents
Contributors
Letter From the Editor
The Emotional Burden
Where Are You Going for Yield?
Ahead of the Curve
How to Use a ‘Collar’
Why Dividends
Is Bond Investing All Uphill From Here?
Four Picks for the Present
Investment Briefs
The Risks of Stretching for Yield
For Banks, Uncertainty Reigns
The Virtues of Dividends
How Well Do You Know Templeton Global Bond?
The Case for Dividends in Emerging Markets
Finding Refuge in Value
Swift, Smooth, and Silent
Crack Open Closed- End Funds to Avoid the Relevance Paradox
Getting Beyond Labels in the ‘To vs. Through’ Debate
Handling the Headwinds
Bonds, Short-Term Bonds
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
A Prisoner of Pricing

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