Your Money: One way to create an income stream

June 20, 2008

Dividend-paying stocks and funds

Key Points

Income generating investments have come into vogue, especially as the Baby Boomer generation eyes retirement. As the 10-year US Treasury bond fluctuates between 3.5 and 4 percent, investors are searching for ways to get more income or yield from their portfolio.

One way is through dividend-paying stocks and mutual funds that focus on dividend-paying companies. To meet the demand, a number of products have been introduced in recent years, and you need to separate the wheat from the chaff.

To properly evaluate dividends, you need to look at the yield. Because it encompasses the dividend divided by the stock price, the dividend yield gives you a better idea of how meaningful the dividend is. For example, Company A pays a $1 annual dividend, and its current price is $100, so the dividend yield is 1 percent; Company B pays a dividend of $1, but the stock price is $20, so the dividend yield is 5 percent. If your goal is to generate income from a portfolio versus growth, then you'll get much more bang for the buck with B.

Your best move is to select a fund that concentrates on dividend-paying stocks. One of the more popular exchange-traded funds (ETFs) is the iShares Dow Jones Select Dividend Index Fund (DVY). Earlier this year, this ETF had a yield of around 4.6 percent and a low expense ratio of 0.4 percent. So if you invested $30,000 in the fund, you could expect to receive dividends or income over the year of about $1,380. Keep in mind the yield is not guaranteed like the rate on a CD.

Don't overlook risk

Of course, some silver linings have a cloud, and in this case, it's risk. Many dividend-paying funds have a high exposure to financials and utilities, such as banks, mortgage firms, and energy companies, which are more likely to pay dividends. Because of its high exposure to financials, DVY through March 31, 2008, was down 15.73 percent over the last year. The lesson: Even though funds pay a high dividend, you're still investing in stocks.

If you'd rather tone down your exposure to financial stocks, consider the Thornburg Investment Income Builder Fund (TIBAX), which recently received the Lipper Fund Award for excellence. TIBAX returned 4.29 percent over the last year through March 31, 2008, compared to a negative 5.08 percent return for the S&P 500. We like the fund's ability to find the most attractive opportunities, plus it's more diversfied than the typical dividend fund. The main negative is its expense ratio of 1.3 percent for the A share, which is high given it has over $4 billion in assets.

While dividend funds can be beneficial to your portfolio, they can be as volatile as the stock market. Use these funds in the context of an overall investment strategy. If your goal is income and growth over a long-term time horizon, you'll find that dividend paying stocks will be a useful addition to your portfolio.

The author is a fee-only certified financial planner with Preston & Cleveland Wealth Management LLC ( http://www.preston-cleveland.com) in Atlanta and Augusta, GA, and a member of the National Association of Personal Financial Advisors.The ideas expressed in this column are his alone, and do not represent the views of Medical Economics. If you have a comment, or a topic you'd like to see covered here, please submit it to Your Money, Medical Economics, 123 Tice Blvd., Suite 300, Woodcliff Lake, NJ 07677-7664. You may also send a fax to 201-690-5420 or e-mail to meinvestment@advanstar.com
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