Will interest rates continue their recent ascent?
If so, many investors will come to question the wisdom of
holding dividend-payingstocks . After all,bonds andCDs are
virtually riskless, and if they sport more attractive yields, why
bother with riskier stocks?
The simple reason: Interest rates (such as on the
10-yearTreasury note ) are unlikely to move past 4%, as I noted
Anystock with ayield above that threshold should still hold
appeal -- as long as thatdividend doesn't look vulnerable to a
reduction or elimination in a changing economic environment.
Yet there is a whole different type of income-producing stocks
that fail to meet that 4% yield threshold but should still hold
great appeal. These are the stocks with fairly low yields right
now but look poised for robust growth, which should set the stage
for future yields well above 4%, using today's prices as abasis
Notes From The Guru
Over the past six months, I've been eagerly awaiting the latest
newsletterissues from my colleague Amy Calistri, author of
. Amy has been spelling out a game plan for how to deal with the
inevitable rise in interest rates that may now be underway,
helping readers to separate winners from losers in a higher-rate
In her most recentissue to subscribers, Amy focuses on
anexchange-traded fund (ETF) that should fare quite well, even as
rates rise higher. Thecurrent yield on thisETF is around 3.5%,
which is below the 4% level I noted earlier.
Yet here's the rub: This ETF is chock-full of companies that
are boosting their dividends at a fast pace, and a 3.5% yield
today could easily morph into a 5% yield in a few years and a 7%
or 8% yield in half a decade.
The combination of solid current and future dividend streams
and potentially robust priceappreciation makes me think Amy has
delivered another winning pick to her subscribers.
There's another reason to focus on dividend growth: "Companies
with a long history of dividend growth display high returns
onequity (ROE)," according to WisdomTree's head of research,
Jeremy Schwartz. The databear that out: The companies in the
widely followed NASDAQ USDividend Achievers Index had a 22%
annual ROE over the past 10 years, according to Schwartz,
compared with 13% annual ROE for all companies in the S&P
I can't share Amy's dividend growth-oriented ETF pick, as that
would be unfair to her current subscribers, but I can share some
similarinvesting options thatcapitalize on this theme.
WisdomTree -- which has pursued the dividend angle for a
number of years withfunds such as
WisdomTreeEmerging Markets SmallCapDividend ETF (
WisdomTree LargeCap Dividend ETF (
-- recently pursued the growth angle with a newly launched ETF,
WisdomTree U.S. Dividend Growth ETF (Nasdaq:
Thisfund uses an index-based approach to select the top
companies in a 1,330-stock universe interms of dividend growth,
sustainability of those dividends (in terms of apayout ratio
above 1.0) and current yield. Tech stocks represent the largest
weighting of any sector, at around 20%.
And that makes sense: The number of dividend-paying technology
firms in the S&P 500 has shot up by one-third since 2010,
according to S&PCapital IQ 's Scott Kessler, who runs that
firm's technology research department. "You need to think about
the tech sector as being uniquely positioned for robust dividend
growth in the years ahead," he adds. (Here's a hint: Amy
Calistri's newsletter readers are well aware of that looming
trend.) Along with tech, industrials, consumer discretionary
stocks andconsumer cyclical stocks are the primary
My primary complaint with this fund is that it is focused only
on large firms (each component has amarket value of at least $2
billion). Smaller companies are often capable of even more robust
dividend growth as they can tend to be earlier in their life
There is the
WisdomTree SmallCap Dividend ETF (
, but this doesn't really have the dividend growth orientation
that we're talking about. The fund's 0.28%expense ratio is
respectable, but cheaper options are available. (Note that
according to recent filings, Wisdom Tree indeed appears to be
poised to launch a small-cap version of the dividend growth
For the ultra-low-cost approach, check out the
Vanguard Dividend Appreciation ETF (
, which owns companies with a history of 10 straight years of
dividend growth. This approach brings two small
First, any companies that were forced to reduce or eliminate
their dividend during the financial crisis of 2008 won't be here,
even though a number of these companies are now back on track
with solid divided boosts.
Second, it ignores the wide variety of tech stocks that only
began paying dividends in recent years. For example,
Apple (Nasdaq: AAPL)
won't be in this fund for another decade.
Still, the Vanguard fund has real strengths. In giving the
fund a five-starrating , Morningstaranalysts noted: "Whereas many
dividend-focused funds concentrate in smaller value companies,
this fund shades slightly toward growth. VIG is a great choice
for a core allocation."
Moreover, like many Vanguard funds, the 0.13% expense ratio is
quite pleasing, so your long-termgains won't be diverted away to
the fund company's coffers.
PowerShares Dividend Achievers ETF (
First Trust Morningstar Dividend Leaders Index
have a similar focus to the Vanguard fund, though they carry
higher expense ratios of 0.60%, and 0.45%, respectively.
Risks to Consider:
Dividend growers should relatively greater appeal than
companies and funds that have limited growth prospects, but all
equity-basedincome producers may sell off iffixed-income rates
move sharply higher.
Action to Take -->
Though rates are coming up off of generational lows, they are
unlikely to rise much higher, killing the dividend party.
Instead, assume a moderate move up in rates over time that still
leaves plenty of room for robust dividend growers in your
portfolio as well.