Investors who are following the herd into dividend-paying stocks or exchange traded funds may not reap the same rewards as those who led the way. Before deciding if dividend investments are still a lucrative way to go, read on.
"Since 1927, high-dividend-paying stocks have returned 11% per year, beating the 8% return from non-payers and resulting in an ending wealth that is 8 times larger. Better yet, they accomplished this feat while incurring less volatility. But dividend-paying stocks outperform only over the long haul, so why might 2012 be a particularly good year for dividend-paying stocks?" wrote Michael Rawson for Morningstar, in a recent article.
Investors are seeking dividend stocks and ETFs because they are looking for an income stream and the current low-interest rate environment shows no sign of changing. Furthermore, some investors may be performance-chasing, as the 100 highest yielding stocks in the S&P 500 outperformed the overall market by about 8% in 2011, reports Jason Zweig on WSJ.com.
Overall, dividend-paying shares are less risky and can be more rewarding than the broad equity market, however, the short term risk of this sector of the market can make investors vulnerable to being in the wrong place at the wrong time, he writes.
One case in point was in 2007, when 29% of the S&P 500 yielded dividend income from banks and financial companies. Howard Silverblatt, senior index analyst at Standard & Poor's, recalls that the scenario did not end well, as banks paying a steady dividend suddenly went bust and investors were punished.
Also consider that from the peak of the market in 2007 until the end of the first quarter 2009, the Dow Jones U.S. Select Dividend index lost 53.8%, versus a 50.2% loss for the S&P 500, according to Fran Kinniry, an investment strategist at Vanguard Group.
As a rule, investors should not consider a sector or asset class just because everyone else is investing in it. Remember that dividend shares are not bonds and do not take the place of them. There is no guarantee that you will collect "interest" or gains, nor that you will get your money back at maturity.
Tisha Guerrero contributed to this article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.