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NEW YORK (Reuters) - Last year, the dividend-growth strategy was a speedboat navigating the doldrums of the stock market.
While plenty of investments sagged from the European and U.S. debt crises, a portfolio mostly in healthy companies paying solid dividends beat practically all comers. Although the Standard & Poor's 500 stock index was flat in price return last year, dividend-oriented funds like the Vanguard Dividend Growth Strategy gained 9.43 percent.
Dividends are usually a good bulwark against most market storms, especially for income-oriented investors. Yet the overall strategy may not do as well in 2012.
"There's a real possibility that dividend stocks could trail this year, but long term, dividends have accounted for nearly half of the S&P 500 investors' total return," according to Jack Ablin, chief investment officer of Harris Private Bank.
Last year, dividends accounted for all 2 percent of the S&P 500 index's total return. This year, if the economy perks up, we may see capital appreciation dominate the big-stock index, or not, depending on whether euro zone angst gushes into North America and Asia.
You also have to consider which stocks paid the healthiest dividends last year. They were bunched up in cash-rich companies that typically hold up during a slowdown, such as utilities. If you're looking to those sectors again for the same returns as in 2011, you could be disappointed.
Will this year reprise the safe-haven stampede?
Institutional investors frequently engage in "sector rotation," favoring entirely different industries than they did the previous year. Will this year's winners be in consumer staples, industrial, manufacturing or technology? In a growth environment, they may pull ahead as the economy expands.
In any scenario, you wouldn't want to be over-concentrated in one sector. Also keep in mind that a big dividend may be a sign of trouble.
Sure, you may be able to find a company like Frontier Communications Corp paying a 17 percent yield, but that doesn't mean the company's stock price is headed up.
The opposite may be true and the market may be relaying bad news. Remember yield is a ratio of dividend to the share price. When the price drops, the yield often rises. Frontier's share price has fallen by about one-half from its 52-week high in February 2011.
Granted, there's no harm in assembling a portfolio of steady companies that raise their dividends on a regular basis. Just make sure you have a diversified portfolio that doesn't place bets in a handful of industries. Several mutual funds and exchange-traded funds can do this work for you.
The SPDR S&P Dividend ETF, for example, picks the 60 highest yielding stocks that have boosted their dividends every year for the past quarter-century. The largest holding in the ETFs accounts for about 4 percent of the underlying index that the managers track, so it is well diversified.
For more of an international focus, consider the iShares Dow Jones Select Dividend Index, which tracks 100 of the highest dividend payers in the Dow Jones Developed Markets ex-U.S. Index. The trade-off here is more European exposure, but the yield is 5 percent and may provide some insulation against a sagging U.S. economy.
If you subscribe to the global slowdown theory this year, dividend-rich companies offer some insulation. Yet they are not magic bullets to protect you from price drops in your favorite stocks.
You'll still need to look to bonds and adjust your portfolio accordingly if deflation is still a problem.
The euro zone will continue to suffer, particularly when it comes to the most ailing countries, including Greece, Portugal and Ireland, and their principal lenders in Northern Europe.
Editing By Lauren Young and Jeffrey Benkoe