Dividend Stocks – a Risky Income Vehicle

The press has been presenting dividend stocks as a viable vehicle for investors looking for income from their portfolio.  As low as interest rates are, this is still not an appropriate use for equities.

Let’s use the Vanguard Dividend Growth fund (VDIGX) as a proxy for this solution.  According to Advisory World (they perform investment analysis data), the 12-month yield on this fund is 1.97% which certainly is better than what you can earn in most savings accounts.  But for someone who needs safety of principal, the risk does not justify the extra income.  For the three months 9/1/08 to 11/30/08, this fund lost 22.26%.  And for those of you who think longer term, the fund lost 20.76% (cumulative) from 3/1/06 to 2/28/09.  Is that really worth that extra 1% or so in income?

If you really are focusing on income and not total return, stick to what works – find a good mix of low-risk bond funds and you can easily surpass the income of dividend stocks with a small fraction of the risk.

Or, if you are looking for total return with an income kicker, consider a diversified portfolio of 60% stocks and 40% bonds.  A hypothetical portfolio similar in composition to Springboard’s 60/40 reports a 12-month yield of 2.48% which bests VDIGX by about 1/2 of a percent.  But even though the yield is higher, the standard deviation is lower: 13.40% for 5 years vs. 15.35% for VDIGX.

The press is just doing their job by reporting the latest and greatest investment “solutions.”  But usually tried-and-true emerges on top in the end.