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3 Dividend Investing Strategies for Safety and Returns

Check out these three dividend investing strategies for safety and return

I love dividend stocks but with more than 7,000 companies paying a dividend, it can be tough to find the best investment for a portfolio. To narrow the field, I like to invest across themes that help me reach my financial goals.

Themes could be around a trend like the aging population and healthcare stocks or around the need for safety. Picking dividend stocks around a theme helps to reduce your risk around a particular company and puts the emphasis on larger forces rather than finding a hot stock.

Check out the three themes below that can help you pick great dividend stocks for your portfolio.

Utilities and Consumer Staples for Yield and Safety

One of the first things investors look for in dividend stocks is a consistent income and safety from the ups and downs of the regular market cycle. Even if dividend stocks did not consistently outperform their non-dividend peers, you get the constant protection they provide when your neighbor is tearing his hair out because his momentum stocks tumbled.

There are a couple of reasons for this. First, dividend stocks tend to be in more mature industries. The steady stream of cash allows the company to start giving some back to investors. Dividends also offer a positive return even when stock prices fall. That cash payment is always going to be positive.

Few sectors provide the safety and yield of utilities and consumer staples. In mature or semi-regulated industries, these companies have non-cyclical cash flow that increases at a steady rate in the worst of times as well as the best.

dividend stocks dividend investing strategiesStocks in the utilities sector offer one of the highest dividend yields as a group, around 3.6% for the Select Sector SPDR Utilities Fund (XLU). The sector can be further separated into regulated and unregulated services or through their different segments like water, gas, electric or alternative energy. Even the unregulated companies operate in a relatively limited competitive environment with allowable rate increases and steady profits.

Companies in the consumer staples sector may not pay a yield as high as those in the utilities sector but growth is usually slightly higher. The Consumer Staples Select Sector (XLP) pays an average yield of 2.7% but still finds growth opportunities in emerging markets and share prices should add to total returns. The companies sell products that everyone needs in their daily lives and have built immense brand loyalty over decades. There is relatively little threat of new competitors coming into the space because of the huge economies of scale the companies have built through global production and distribution.

Investing in utilities and consumer staples is not without risk. For the safety of stable growth, you often give up some return so do not expect the share prices to shoot higher in any given year. Since utilities cannot increase their rates quickly, their shares react like bonds when interest rates rise. That means when interest rates increase, other investments may be more attractive and the shares lose their value. Companies of consumer staples are able to increase their prices a little faster but competition usually limits the ability and neither sector is a good hedge against inflation.

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The New Breed of Dividend Tech Stocks

Investing only in the safest dividend stocks and sectors means you may be giving up growth that will help meet your financial goals.

For portfolio growth, the new breed of technology companies that pay dividends are a great addition. Some of the larger tech dividend stocks like Microsoft (MSFT) even pay yields higher than the general market. These companies still see relatively strong sales growth in developed markets and faster growth opportunities in emerging markets around the world. Often, these companies also buy growth through acquisitions of new technologies or patents.

Many of the new breed of tech dividend-payers don’t generally pay a high yield so you will need to sacrifice some current income for growth. Companies in the sector face more competition than in sectors like utilities or consumer staples so there is no guarantee of higher share prices. I like to focus on an established management team that has historically proven it can execute on competitive goals and keep the company relevant.

Real Asset Dividend Stocks for Inflation Protection

Even though inflation has dropped to historical lows, it can eat away at your income over a longer period. That cash flow you collect now will only buy two-thirds the amount of stuff in 20 years even at a low 2% rate of annual inflation.

And low inflation hasn’t been the norm. The dollar lost 90% of its purchasing power over the five decades to 2012.

Dividend Stocks and Inflation

The companies that own hard assets like pipeline master limited partnerships (MLPs) and real estate investment trusts (REITs) are a good addition for inflation protection, though they can pay off in other ways as well. While commercial property and energy infrastructure may need maintenance from time to time, these assets generally tend to increase in value with the decline in dollar purchasing power.

Another benefit of the group is the tax-advantages gained by either investors or the companies themselves. Companies in MLPs and REITs avoid corporate income taxes so it is a much more financially-efficient way to operate the assets than at a traditional company. This means higher profits than would normally be earned.

Within MLPs specifically, the new energy revolution in the United States is driving the need for more pipeline transportation and storage. Railroad carriers are booking strong profits because pipeline construction is not keeping up with demand. That tells me the volume of energy products moving through pipelines will continue to increase even when new pipelines are built. Since most of these companies book their revenue on volume rather than commodity prices, the drop in oil prices hasn’t been catastrophic.

The real estate bubble and bust may actually benefit investors in real estate over the long-term. The commercial and residential real estate markets got crushed during the bust and many regions are still seeing strong price gains back to fair value. The memory of the bubble should keep markets from overheating for a long time and property prices could continue their historically stable climb higher.

These aren’t the only themes within dividend stocks but they should get you started in adding some good cash flow to your investing portfolio. Remember to always invest according to your need for return and tolerance for risk, regardless of what someone else says about a stock. For investors that want an even safer stream of cash flow, don’t forget to check out bonds and investments in peer loans.

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