By John Wasik
CHICAGO Nov 30 With a tax increase on dividends
and capital gains looming, high-dividend paying stocks may hold
up well - even if investment income rates climb on Jan. 1.
Unless Congress acts by the end of the year, taxes on
dividends will automatically rise from the current 15 percent to
as high as 39.6 percent. While that sounds like a draconian
increase, it should not discourage investors from owning
high-dividend paying stocks nor should it trigger a lasting
You can blame inertia, but individual investors are likely
to stick with their dividend stocks anyway. And those who do may
even be rewarded for the fear factor of higher rates. Companies
like Wal-Mart have moved up dividend payments to
December. Others like Costco, Wynn Resorts and
Tyson Foods are declaring special dividends, some of
them quite substantial.
If history provides any clue, the market should get over its
anxiety quickly and move on. According to a study by Ned Davis
Research, dividend stocks performed well during past periods of
higher dividend taxes. The firm studied years when rates ranged
from 28 percent (1988-1990) to 70 percent (1972-1978).
In every period studied, except for 1987, high-dividend
stocks outperformed non-dividend payers. The margin of
outperformance was as high as nearly 15 percentage points.
What's the connection between tax rates and dividend-paying
stock returns? According to Milller/Howard Investments in a
recent report: "There is no correlation between lower dividend
taxes and the performance of dividend-paying stocks."
There are some fundamental financial and psychological
reasons why dividend payments and tax rates are unlinked. Here
are the four most compelling ones:
1. Investors still know how to play the ongoing contest
between bonds, insured vehicles and dividend-paying stocks.
Savvy investors buy on the spread, or the difference between
asset classes. Right now, that gap is big.
The national average rate on a one-year certificate of
deposit, according to Bankrate.com, is a miserable 0.29 percent,
although you can find a CD yielding 1 percent if you shop
You can get a 2 percent yield on the Vanguard Dividend
Appreciation ETF right now. The exchange-traded fund
holds a basket of stocks that consistently boost their
dividends. This spread is unlikely to narrow soon since the
Federal Reserve has said it will leave interest rates close to
zero into 2014 if the economy continues to be sluggish.
I know I'm comparing apples and oranges - an insured
investment with stocks - but long-term, total-return investors
are willing to take on the extra risk.
2. The best dividend-paying stocks combine income with
potential growth in the payout over time. Conventional bonds and
insured deposits pay a fixed rate until maturity. While there
may be some compounding, your income stream won't change during
the time you hold your bond to maturity.
Dividend payers can increase their payouts every quarter -
and many have done so consistently over time. Energy company
Chevron, for example, has been paying dividends since
1912; Colgate-Palmolive since 1895, and Stanley Black &
Decker since 1877, according to Investorplace.com's list
of "dependable dividends."
Investors will continue to embrace consistency paired with
dividend growth even if tax rates climb.
3. Dividends still provide a modest cushion in calamity.
While dividend-payers still are subject to stock market risk,
they are much better to own in a pinch in a low-yield,
If you examine the most elite companies that have raised
dividends for at least 20 years - the S&P High Yield Dividend
Aristocrats - those companies have outpaced the broad S&P 500
index over the past one, three and five years through 2011.
Even when you include the disastrous results from 2008, the
Aristocrats turned in a 1.53 percent return for the half decade
versus a negative 0.25 percent for the stocks of the S&P 500.
Keep in mind that one-third of total stock returns have come
from dividends since 1926, so in the absence of appreciation,
dividends provide some insulation in bear markets
4. Total return still matters. Yield isn't the only reason
dividend payers will prevail in the event of a tax increase.
Companies also offer the potential for capital appreciation in
The most consistent payouts come from sectors of the economy
that straddle defensive and growth categories. Utilities, for
example, many of which have been around for a century, have
traditionally paid out large portions of their cash to
shareholders. Combined with an increasing demand for electricity
and energy, they've done well in recent years.
The Utilities Select Sector SPDR, for example, has
returned nearly 14 percent over three years through Oct. 30,
with a recent yield of about 4 percent.
The Vanguard Consumer Staples ETF, which tracks an
index that holds "consumer defensive" companies like Altria
and Coca-Cola, is up nearly 15 percent with a 2
The market will get nervier the closer Congress gets to the
end of the year - dividend payers will likely provide the modest
bulwark they always have for buy-and-hold investors. There are
no guarantees, but the lion's share of dividends won't suddenly
disappear just because tax rates change.