Historically, dividends are responsible for about half of the stock markets’ total return equation. But in the go-go days of the 1990s, dividends became insignificant as investors leapt into technology and other growth stocks; CEOs ploughed cash back into buybacks at the expense of dividend hikes for the most part. And as the market skyrocketed that decade the dividend yield as a percentage of the markets’ total return shrank.
The big problem with dividend investing today is that many companies are cutting or eliminating dividends altogether. That’s especially the case with the distressed financial services sector where dividends have been almost entirely cut or substantially reduced since last year.
Just how the market can recover much quicker without bank dividends – a big chunk of the Dow – remains to be seen.
A better way to ride a recovery if you feel bold enough is to buy convertible bonds instead of common stocks. Your upside, of course, won’t be as snazzy as equities but at least you’ll have some income to cushion any draw-down. Convertibles suffered their worst year in history in 2008 – crashing almost 40% -- but have gained more than 10% in 2009.
An excellent convertible bond fund is Vanguard Convertible Securities Fund (MUTF:VCVSX). The Fund has employed the same manager since 1996 and has the lowest expense ratio in the business. In 2009, the Fund has gained 15.5% compared to 1.3% for the S&P 500 Index.