With markets widely expecting the Federal Reserve to cut interest rates at its September meeting, dividend-paying stocks are about to get their moment in the sun. Fed funds futures trading data suggests a rate cut from the current range of 5.25% to 5.
5% is a certainty next month, according to the CME FedWatch Tool . When that happens, investors hoarding cash in money market funds – which today are paying seven-day annualized yields exceeding 5% – are likely to take a hit to their portfolio income. "As you look forward from this point onward, this 5% [in money market funds] may not materialize as the Fed starts cutting, so where can you find income as the risk-free rate starts to come down?," said Stephen Tuckwood, director of investments at Modern Wealth Management in Laguna Beach, California.
"It's a good idea to look at dividend-paying stocks." Those dividend payers haven't seen the same runaway appreciation that the broader market has enjoyed in 2024 – but they could be primed for a bounce: The ProShares S & P 500 Dividend Aristocrats ETF (NOBL) has a total return of 10.1% this year, compared to the S & P 500 's advance of almost 19%, including reinvested dividends.
NOBL .SPX YTD line NOBL ETF vs the S & P 500 in 2024 Investors should be discerning as they shop for these dividend-paying names and avoid the siren call of names that have high yields that are too good to last. Not all dividend payers are alike High dividend yields may be eye-catching at first, but they should prompt questions from investors.
"When I see a dividend yield that's north of 5%, 6%, 7%, you start wondering what's wrong here: Do I really know the whole story about this company? Why is this dividend yield so high? Does it seem unsustainable?" asked Rick Wedell, chief investment officer at RFG Advisory in Vestavia Hills, Alabama. High dividend yields could be the result of a sharp decline in share price, for starters. They could also indicate that a company is under stress and likely to cut its payment, especially risky in the case of an economic downturn.
"The highest yielders are often caught in two challenging cross hairs: very slow growth in the early/middle of the cycle and potentially [at] risk of a dividend cut later cycle," wrote Chris Senyek, chief investment strategist of Wolfe Research, in a Monday report. To safeguard capital, Senyek's team prefers names in the second quintile of dividend yield. Companies the firm called out include Texas Instruments , which is up more than 23% in 2024 and pays a dividend yield of 2.
5%, and supermarket chain Kroger , up 15% this year and yielding 2.4%. Key factors to watch In the search for individual dividend payers, Tuckwood points to a few key factors for investors to consider.
First there's the quality of earnings: Investors should find a company that's growing at a healthy rate and that has a solid balance sheet, along with strong free cash flow as that's ultimately where dividend payments come from. "History is often a consideration here: Has the management team been committed to the dividend payout?" he said. "It can be an easy line item to cut when management wants to hunker down, and we want to make sure it's not something they take lightly.
" Investors should also pay attention to value and sector tilts that they may inadvertently create in their portfolios by scooping up dividend payers, Tuckwood said. Big dividend payers tend to include names in the utilities and consumer staples sectors, and a concentration in those corners of the market can throw off a portfolio's allocation. Finally, investors should be mindful of the benchmark they're using to measure their success.
"If the S & P 500 is something you measure performance against over time, recognize that by being heavier in dividend payers, your journey is going to be a little bit different," Tuckwood said. "There will be periods of time when the portfolio performs differently than the broader average." Though investors can simplify their holdings by going with an exchange traded fund with a focus on dividend payers, they should still be aware of the style at play and the underlying companies.
"Even if you do own a fund, you will end up with some value traps in there, and you can't help it," said Daniel Sotiroff, senior manager research analyst at Morningstar. He noted that an analysis of high dividend yield ETFs revealed poor performance during the Covid-19 drawdown in 2020. "It wasn't any secret: Many had energy stocks, and the oil futures went negative for a few days.
They are overweight energy and did poorly," he said. Investors on the hunt for yield should be reasonable, Sotiroff noted, adding that the Vanguard High Dividend Yield ETF (VYM) is "a good proxy for a reasonable high yield mutual fund or ETF." VYM has a total return of about 14% in 2024, and it's a cheap choice with an expense ratio of 0.
06%..
