High-dividend stocks are all the rage. $30 bn net has gone into mutual funds focused on these stocks, compared to $140 bn net that has exited all US stock funds in the past three years. The argument is seductive: in a low interest-rate world, high dividend stocks give you income plus growth. And they have done well the past several years. But like most “can’t miss” investments, if you load up on them, you are playing with fire.
First, the risk. Over-weighting toward dividend stocks means you have reduced your diversification. In 2006-8, when they were also popular, high dividend stocks were over-weighted toward banks and auto companies. In 2008-9, those companies’ stock prices fell dramatically and dividends were slashed — far more than the market average. Today, the over-weighting is to consumer staples, energy and utilities. I can’t predict whether a grim fate will befall these sectors, but you take increased risk by putting more of your eggs in fewer baskets.
Second, the misperception. Some investors think dividend stocks are a substitute for bonds. That’s a mistake. Bonds usually provide safety in turbulent markets. In the 2008-9 crash, bonds were steady or in many cases increased in value. Stocks — including high-dividend stocks — were hit hard. Vanguard and others have recently published analyses that prove this point.
When any asset class — high-dividend stocks, junk bonds, real estate, etc. — becomes particularly popular, that’s often a sign. I can’t time the market. But I know that when everyone loves something, it’s often over-priced. Broadly diversified, long-term investors, who refuse to chase the latest hot idea, will almost surely do better.