Investment Consult

By Lewis J. Altfest, CFP

Dividends look better than ever

• Companies that pay dividends are usually well managed.

• Proposed legislation would make dividends tax-free.

During the 1990s, people who touted the virtues of stocks that paid dividends were considered old-fashioned and out of touch. Dividends were unpopular for several reasons, but mostly because corporate executives and investors wanted them reinvested rather than distributed, to help further boost stock prices. Executives reaped more from their stock options, and individual investors paid lower tax rates on their long-term capital gains than they would have paid on dividends.

Then came the stock market collapse, and after that a rash of companies found guilty of cooking the books. Since then, investors have been skeptical of earnings statements. Companies that pay dividends now look better than those that don't, because dividends are actual cash payments, which are less likely to be manipulated.

But that's not the only reason to take a fresh look at dividend-paying companies. Firms that pay solid, ever-rising dividends are more likely to have a good management team in place. And, in my experience, their executives are less apt to make poor decisions regarding mergers and acquisitions. Investors in these companies recognize good leadership, and many of them reward it by reinvesting their dividends in return for additional shares.

People may have even more incentive to buy well-managed companies if President Bush's proposed tax plan goes through and dividends become tax-free. Whether this plan actually will come to pass is uncertain, though, given that it would primarily benefit the elderly and wealthy, who own more dividend-paying stocks than the general public.

Even if congress rejects Bush's plan, you'd still do well to own investments that pay dividends. As I mentioned last year, mutual funds that focus on high-yielding utilities and real estate investment trusts are smart choices. (See "How to profit in today's market," Sept. 23, 2002.) They offer generous dividend yields and should provide solid returns over the next several years. Two no-load funds that I'm currently recommending to my clients are Undiscovered Managers REIT Fund (888-242-3514) and Fidelity Dividend Growth Fund (800-544-8888). Both have earned Morningstar's highest rating.

The returns for Undiscovered Managers REIT Fund have beaten those for Morningstar's real estate category benchmark in each of the past four calendar years. In 2000, the fund gained 31.5 percent, more than 40 percentage points better than the return for the S&P 500. The fund's management team holds a small number of REITs—25 to 35, generally—and tends to trade infrequently. That limits the amount of capital gains distributed to the fund's shareholders.

Another thing I like about the fund is that the managers plan to close it to new investors when its assets reach $250 million. (It's at about half that total now.) This will help prevent a flood of new money from investors who simply chase performance instead of investing for the long term.

Fidelity Dividend Growth, my second choice, is a blend of large-cap stocks, several of which currently pay nice dividends—among them Citigroup, Fannie Mae, and General Electric. So far this year the fund's returns have been disappointing, but over longer time frames they're above average relative to those of its peers. I expect the fund to do much better toward the end of the year, as the economy improves. I think a return of 5 to 10 percent is realistic.

The author, a fee-only financial planner, is president of L.J. Altfest & Co. (www.altfest.com), a financial and investment advisory firm in New York City, and is an associate professor of finance at Pace University. The ideas expressed in this column are his alone, and do not represent the views of Thomson Medical Economics. This column appears every other issue. If you have a comment, or a topic you'd like to see covered here, please submit it to Investment Consult, Medical Economics, 5 Paragon Drive, Montvale, NJ 07645-1742. You may also send a fax to 201-722-2688 or e-mail to meinvestment@medec.com.

Lewis Altfest. Investment Consult: Dividends look better than ever.

Medical Economics

May 23, 2003;80:20.