Two Huge Problems with Dividend Stocks Right Now

Watch Out For Dividend StocksDividend stocks have been quite popular lately and for a good reason. Most quality dividend stocks pay out a consistent amount of money on a fairly set time schedule. Many produce a better yield than high interest rate savings accounts and CDs. Some people have invested solely in dividend stocks as a way to generate passive income and that raises a huge red flag for me. I have two problems that make me wary of dividend stocks right now so make sure you pay attention.

Dividend Stocks are Extremely Popular Right Now

Whenever everyone flocks to a certain type of investment it raises a red flag to me. I am not a stock analyst and I’m not saying that dividend stocks are in a bubble period. I do think this presents a problem to everyone who is invested in dividend stocks. Why?

What happens when the economy picks back up, interest rates rise, savings account and CD rates rise and dividends no longer seems as desirable as they once were? People sell their dividend stocks and put their money in other investments. Whenever an exodus starts from a particular type of investment prices drop. Then when you get out too late you’ve lost a bunch of money that you were relying on for your income needs. Whoops.

On top of that it isn’t just financial bloggers that are singing the praises of dividend stocks. If you ever watch the Suze Orman Show you’ll often see her talking about how dividend stocks are an option. She does make some good points and help many people get their finances on track so I have to give her that. The problem is once I see all of these big names urging people into one particular option it worries me. Shouldn’t everyone have bought a house 5 years ago too? It is the American dream after all!

Dividend Stocks Are Harder to Properly Diversify

If you put all of your money in stocks in general you aren’t well diversified. On top of that, narrowing your selection down to one type of stock makes you even less diversified. Granted you can buy dividend stocks in different sectors like consumer goods and energy. The problem is that you’re still all in stocks and all in dividend paying stocks at that.

I recently read an article in Money Magazine that reinforced my thoughts on diversification with dividend stocks. The article states that not all stocks pay dividends so that limits the options you have. On top of that if you’re looking for the higher yield stocks to increase your income you’ll be poorly diversified between the sectors. If you are invested in some of the more popular dividend funds the article states that you’ll have more than a proper allocation of consumer, industrial and basic material stocks while you won’t have enough technology, financial services, and health care stocks.

I Don’t Invest In Individual Stocks

As I mentioned before I am definitely not a stock analyst and I don’t even invest in individual stocks. You should never take any of my musings as financial advice because I am not a financial advisor. That said, I still hope to at least make you aware of some of my thoughts on why dividend stocks worry me. Dividend stocks might work out just fine and there won’t be an exodus in five or ten years. I just don’t see how that can happen with everyone hyping them up as much as they have been lately.

What is your take on dividend stocks? Do my concerns concern you? If not, why not? Do you think dividend stocks are over hyped right now?

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About Lance Cothern

Lance Cothern, a Certified Public Accountant (CPA) licensed in the Commonwealth of Virginia, is the founder of Money Manifesto. You can read more about him here or connect with him on Facebook, Twitter, Google+ or Pinterest.

Comments

  1. Funancials says:

    You have a good point. The example I could think of is Gold. Probably late to the party if you’re advertisements on the radio about it.
    I’m not too worried about dividend stocks though. There are so many people not investing in stocks that prices will go up when everyone jumps back in. There was such a giant movement to bonds, treasuries, and cds

  2. Great tip on not flocking to the hot stock. To paraphrase Warren Buffett, get greedy when others are scared and scared when others are greedy. Also, I’m not an individual stock person either. I just don’t have the time to research each and every stock. Let a mutual fund manager do that for you, IMO.

    • Warren Buffett also LOVES dividend paying stocks (even though he doesn’t pay one from Berkshire). Just look at what he owns.

      I am personally a big fan of dividend stocks and have been investing in them for years. They have treated me very well over the years and have helped me grow my positions in some very strong companies. I also have a high level of confidence in my own research and investment knowledge. I don’t just buy a stock because some report told me to. That being said, many individuals should probably not bother with individual stocks, they are simply too risky for most people.

    • Buffett is a smart man 🙂

  3. “Whenever an exodus starts from a particular type of investment prices drop. ” I definitely agree with this. Things can get volatile quick and people can get burned if they aren’t diversified.

  4. As part of my 401K, we do have an “income fund” (ie. dividend stock mutual fund) as well as a “growth fund”, which relies more on the stocks increasing in market value. We consider them part of a fairly balanced portfolio, so at least for now, we’ll keep the income fund. Overall, though, this fund represents a pretty small portion of our total assets.

  5. I agree with you in that they are over hyped! Individuals hopefully are diversifying and not only focusing on dividend paying stocks.

  6. Yep, I agree with the point to flee when others flock. However, that’s a generality, and my first response to any generality is to challenge it. This one can do with a little challenging. Let’s see if I can back it up.

    There are different kinds of dividend stocks, just like there are different kinds of people.

    REIT stocks are nowhere near the highs they will reach in about 3-4 years, so they still have sufficient headroom to be interesting. The recovery has just started, and real estate has just started recovering. Shopping malls will be raising their occupancy and their rents over the next two to three years. That means their incomes will rise, and by law a REIT has to pay out all its income as dividends. I’m not into any retail REIT, but I know there are several good buys out there.

    mREITs (REITs based on mortgages) pay ridiculous dividends, like 12%. That’s obviously not sustainable, but if you’re prepared to watch them daily, they might be good for at least two more years. I’m not a daily watcher, so I stay away from them. NLY is the bellwether.

    MLPs like Kinder Morgan are driven by other fundamentals – in their case energy demand (in this case, they’re an oil and gas pipeline company). If you believe the economy will keep growing, then you believe oil consumption will grow and, with that, dividends. I have a core holding of KMP and I’ll probably keep those close to forever. They’re a well managed company IMHO and they pay something like 6% on today’s prices. I don’t think they have ever cut their dividend, but I haven’t looked back all that far.

    Preference shares. These are hybrids between bonds and stocks, and price-wise they’re less volatile than both. You have to dig to find them because they don’t show up on the regular stock listings. but most pay around 7-8%. I used to work in the hotel industry so I know some of those companies from the inside out. The two companies whose pref. shares I’ve invested in are LaSalle (LHO) and Felcor (FCH). FCH.PR.C (C series) has a catchup dividend priced in at the moment. After you receive the catchup dividend, the price will return to its normal level. And at that point your return should be around 8% per year. It never goes up, but it never goes down, either, so if safety is what you want, it’s hard to beat preference shares.

    As with all things, don’t buy the generalities. Remember, the media are the same people who tell us we’ll never retire (Lance’s guest post today at FMF). So if you’re not to listen to them there, you’re not to listen to them here, either. 🙂

    If in today’s uncertain market 6-8% is not enough return for you, pray share what’s the better investment. My retirement fund needs to know… 🙂

    As with all investing, real estate or securities, you are one person. You only need to look for one deal that makes sense. There always is. But it rarely comes to you. You need to look for it.

    And you will never find it in the media.

    • I totally agree that you need to do your own research and base your decisions off that. I’m sure there are some good dividend payers out there.

  7. Although I have a few dividend stocks, I prefer mutual funds. I am more interested in growth than dividends at this time. I will probably add more dividend funds as I get closer to retirement.

    • That is my thought as well, although toward retirement I’m hoping it will be a small percentage in dividend stocks because I don’t need the risk to get the return due to my hopefully large nest egg when I retire.

  8. Great points. I tend to agree that we need to be leery of dividend paying stocks. As has been noted, Buffett states to sell the greed and buy the fear. Everyone and their brother is going into dividend paying stocks because they want the return, which I get. But, everything should not be there. If you’re completely in dividend payers, you’re bound to run into trouble because SO much money is going into them. That said I do tend to buy individual stocks as well as some low cost ETF’s and have only 1 or 2 dividend payers. I am pretty well diversified. I tend to avoid mutual funds, because I can lose money just like they can…so why pay someone else to do it for me?

  9. Have you thought about investing part of your savings in dividend stocks at all? I’m in the same boat, where I don’t know much about it, but maybe playing the game a little and doing a small amount of research could help? Just some thought…

  10. Veronica @ Pelican on Money says:

    Lance, dividend stocks have been a hot issue with financial bloggers but I haven’t seen anyone advise to invest in this type of stock only. Maybe I’m reading between the lines? Hmm.

    • Oh I don’t think anyone has said move solely into dividend stocks but I bet there are some people out there who do that. I’m just trying to make sure everyone realizes that they need to think about their strategies. Some dividend stocks may be great but if you’re investing in them relying on the income you need to be very aware of everything that is going on.

  11. Amy @ Pelican on Money says:

    Thanks for taking the time thread this post Lance. I’ve been in stocks and bonds for many years now and when people flock to something it tends to mean that the upswing is coming to an end and the people that have made their money are getting out of the stock. I have seen this numerous times, not to mention then bit by this as well. Just like anything we should do a very good analysis and review prior to purchasing any stocks. Even if you see a lot of people jumping into a stock, the analysis will provide the data you need to know whether or not the buys are based on emotion or more solid information such as the company’s fundamentals, etc.

  12. If you own an S&P 500 index mutual fund, you already own about 400 dividend stocks indirectly. I do have 1 single stock (small % of total net worth) and it has been producing dividends for 3 generations, I wouldn’t call that a fad–just stuff wealthy people do.

    • Dividends stocks definitely have their place, I just wouldn’t jump all into dividend stocks as a way to produce income in retirement or solely rely on them and nothing else.

  13. Very contrarian post from you! I am not in tune with everything in the markets, but I have seen a lot more stuff about dividends in the past year than I had in the many years before. Do you think it’s time to sell them?

    • I don’t know if it is time to sell or not. I’d look at the fundamentals and see if it is still a good investment before I made any decision.

  14. I do have dividend stocks, but most of my money is tied up in mutual funds and in particular my 401(k).

    I have to admit the more I hear about how great dividend stocks are on the TV, the more nervous I get about them as an investment vehicle too.

    There are dividend stocks that are worth holding though, especially if they keep increasing their payout year after year.

    Tough call, I’m on the fence on this one.

  15. I always liked Sir John Templeton’s approach: if everyone looks one way for investing, by definition he automatically looks a different way. I think that applies here.

  16. I agree but I also disagree with this, you should only be in dividends if you are a long term investor. The ups and down’s of share prices should not sway you as you are in it for the income of dividends, granted a company might go bankrupt and you will lose that income source and initial investment. But if you buy something like JNJ and Coke who have been around longer than most peoples grandmas I dont see a need to worry. Keep it, hold it, and reinvest dividends to retire early. Good Post.

  17. I’ve been writing about this topic as well. Watch out, I smell a bubble.

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