Rules of the Game: Dividend Fallacies

 | Jun 10, 2013 | 12:00 PM EDT  | Comments
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A portfolio consisting of large, mature, dividend-paying stocks is conservative, right? Wrong!

OK, you knew I was going to say that, but it's always fun to point out a common misconception.

Wall Street, through its army of wirehouse brokers and salespeople, has done an admirable job of convincing the investing public that some equities are "safer" than others. Remember: For every stock that's bought, there is a seller, and for every transaction, there is a commission.

It's not necessarily a bad thing to get paid while sitting through sideways or down markets. Apple's (AAPL) decision last year to reinstate its dividend (it has paid small cash dividends in the '80s and '90s) meant the company was not sitting on a hoard of cash without sharing the wealth. For investors, it's not supposed to be about cool product launches and the cult of a CEO; it's supposed to be about sharing in the company's good fortunes.

Most of us are accustomed to techs, retailers and other young growth companies putting their cash back into the company, rather than paying it to investors. As some of you know, I spent years as a growth-stock trading coach, and I dismissed dividend-payers as boring, slow movers.

I've long ago evolved my views of a balanced retirement portfolio. (Hint: You can't just buy Fleetcor (FLT), Lithia Motors (LAD) and Lumber Liquidators (LL) and think you have a good retirement plan. But I digress.) Just as it's important not to assume that your portfolio should be growth, growth, growth, it's also crucial not to expect that dividend payers are more reliable.

Let's go back in time, maybe to pre-2008. Banks have historically paid dividends, but in many cases, that came to a screeching halt with the financial crisis. That was a condition of the government bailouts.

Think about this: Why do banks consider it so important to have a dividend strategy? Management and boards are well aware that dividends attract buyers. Again, it comes back to investors who have been educated to believe there is some "safety" in companies that dole out these payments on a regular basis. For retirees, the payments are often a reliable part of their income stream.

So, back to the banks. Obviously, they couldn't take their Federal bailout funds and hand them out to the public. But shareholders interpret the dividend as a sign of a well-run, stable company. In certain sectors -- like banking -- it's almost a necessity to pay dividends to draw investment.

Remember the hoopla back in 2010 and 2011 when the banks began gradually reinstating dividends, or raising them again? Institutions began accumulating shares again, because the dividend-paying mutual funds are a big hit with investors who want the stability and perceived safety.

I'm not against investors sharing in the profits; don't get me wrong. But the financial crisis should be a fresh memory that large-company payouts give an illusion of safety, not reality. I just want to remind investors that there is no "conservative" portfolio when it comes to equities. As the saying goes, there is always risk inherent in investing -- even when you have been led to believe that it's safe.

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