The ever-present question facing dividend investors is what the optimal balance of dividend income versus dividend growth should be in a portfolio. High-yielding stocks may provide a fat dividend yield, but limited growth, which may reduce their appeal versus a classic dividend growth stock such as McDonald's (NYSE:MCD) or Coca-Cola (NYSE:KO) that pays a more modest dividend yield in the 3% range, but provides dividend growth near 10%.
I would suggest that having a few high yielders in the portfolio is something that can be a good thing for any dividend investor, particularly those that are just starting out. I own several high yielders in my own dividend portfolio, including BP (NYSE:BP) and Telstra (OTCPK:TLSYY), the latter which I picked up for a dividend yield of close to 10%.
Immediate guaranteed return
Companies like AT&T(NYSE:T) offer dividend yields of near 5%, while providing dividend growth of only 2%-2.5%. For investors in these stocks, the dividend return effectively contributes a significant amount to the total return that an investor derives.
In contrast, stocks like American Express (NYSE:AXP) and Moody's (NYSE:MCO), which have provided higher dividend growth over time, are far more reliant on strong capital returns to generate total return for investors. Both American Express and Moody's offer dividend returns of 1.5% or less.
The significance of such a strong contribution from dividend income to a investment return should not be understated. Dividend income makes a significant contribution to a stock's total return and can form the basis for close to 50% of a stock's total return on average, and even more so during periods of poor stock market performance.
High-yielding dividend stocks provide you with cash in the bank today. They provide a real return and less of a promise of speculative return through capital growth, which essentially is the case with low yielding or moderate yielding stocks.
The advantage to investors of a higher-yielding stock is they don't need to make bets on capital growth. They don't need to pick which stocks will experience strong capital returns and how quickly such stocks will be rewarded by the market.
Shield against high volatility
In my dividend growth journey, my initial forays into stocks included some high volatility disaster stories that were speculative and didn't pan out. One of the great things about high-yield dividend stocks is that they tend to have lower than average volatility. Not only do you get paid to wait, but more importantly, higher-yielding stocks help provide a buffer against considerable market fluctuations. They help make it less likely that downturns in the market will result in investors getting scared by volatility and selling out. This is because these higher-yielding stocks can still generate considerable total return purely from the contribution of a high dividend, in spite of the general turmoil that may be happening in the stock market.
Verizon (NYSE:VZ), for example, has a beta of only 0.45, meaning it moves approximately half as much in price as a general move in the market. Thus, when the market takes a precipitous dip, Verizon doesn't dip as much, in general. Reducing the amount of tension and stomach churning when establishing a portfolio can be very important to provide confidence to develop and stick to a strategy.
In 2008 for example, as the S&P 500 went into a nosedive and dropped 37%, Verizon stock not only outperformed the S&P 500 in terms of stock price performance, but in addition still managed to pay out a 5.4% yield, which may have provided a strong enough reason for an investor to hold onto a stock. Substantial dividend yield likely provides some basic support for these higher-yielding dividend stocks.
Maximize Dividend Reinvestment
Automatic dividend reinvestment can be a great way to accelerate your annual dividend stream. Consider the example of an investor who had invested $10,000 in Verizon 10 years ago.
At the beginning of 2004, Verizon was trading at around $40 per share and paid an annual dividend of $1.50. The stock now trades for about $49 and with an annual dividend of $2.12.
If you chose not to reinvest the dividend, you would have collected almost $5,000 in dividend payments, over the 10-year period.
If the dividends were reinvested, however, the number of Verizon shares that the investor would now hold would have substantially increased from the initial share count. An annual dividend of $530 with the original share count is instead $752 with the shares having been reinvested.
Having high-yielding stocks as part of a dividend portfolio maximizes the amount available for reinvestment. Simply put, the higher the yield, the more available for reinvestment and the greater your annual dividend income.
Achieve Portfolio Diversification
Higher-yielding dividend stocks also allow you to diversify your dividend portfolio to include lower-yielding dividend stocks without significant new capital investment. Why may adding low yielders into a dividend portfolio be something to consider?
Dividend growth stocks that have a lower initial yield yet faster growth may take a longer period of time to provide the same dividend income of a higher-yielding stock, but if you have a long holding period, you can really start to get a strong dividend pay-off midway into your holding period.
Visa is not traditionally thought of as a dividend growth stock due to its relatively small yield of 0.8%, but it has provided dividend growth of close to 30% per annum over the last 4 years.
Most significantly, the total return performance of low yielders can significantly juice a portfolio's total return. Visa and MasterCard have significantly outperformed the return on the S&P 500 in the last 5 years, with a $10k investment in MasterCard and Visa worth well over $40k today, compared to a return of $22.5k for a similar investment in the S&P 500.
For an investor with a limited ability to deploy fresh capital, high-yielding dividend stocks can help create a natural diversification play without requiring new investment.
Disclosure: The author is long MA, V, BP, TLSYY, MCD, KO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.