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For income-starved clients with long-term time horizons, there's rarely a bad time to consider dividend stocks and funds. Still, there's a school of thought that dividend-paying equities can be vulnerable against the backdrop of rising interest rates, which will almost certainly arrive next month.
“This time could be different” isn't a phrase folks like to hear with regards to financial markets, but it could well prove accurate for dividend equities in the upcoming rate tightening regime. That sentiment comes with the caveat that selectivity is imperative.
Employing that selectivity isn't difficult. Dividend growth is the strategy to embrace in an environment marked by the dual headwinds of persistent inflation and rising interest rates. With broader benchmarks sagging to start 2022, dividend stocks are proving their mettle as a variety of dividend-oriented exchange traded funds are holding up well compared to broader equity indexes.
That's welcome relief for clients, particularly those growing frustrated by slack performances by growth stocks and those needing more income in a climate of still low bond yields. Advisors should expect dividends to be in the spotlight again this year with payout growth providing some optimism for broader market performance.
Dividend Royalty Matters Today
I recently noted that the S&P 500 Dividend Aristocrats Index, which requires that member firms have minimum dividend increase streaks of 25 years, is an idea for advisors to consider – and one clients will like – as both inflation and interest rates move higher. There's support for that thesis.
“With looming inflation concerns and the prospect of further volatility, the case for dividend growth strategies may be particularly compelling. The ability to consistently grow dividends every year through different economic environments can be an indication of financial strength and discipline,” according to S&P Dow Jones Indices.
Obviously, meeting the mandate for admission into the Dividend Aristocrats Index isn't easy. It's exclusive territory as reflected by the fact that there are just 65 stocks in the benchmark. Alone, that's notable, but even more impressive and relevant to clients is the point that that 32 members of the index have dividend increase streaks of at least 45 years and 15 boosted payouts for at least 50 consecutive years. That confirms dividend growth is a valid inflation-fighting strategy.
“Inflation is the enemy of bonds because it erodes the value of their fixed coupons. However, companies have the advantage of being able to grow their dividends to outperform inflation over the long term,” adds S&P Dow Jones Indices. “Dividends paid by current constituents of the S&P 500 Dividend Aristocrats have grown on average by 10.6% a year over the last 25 years compared with ~2.25% per year for inflation.”
Good Yield Idea, Too
As noted above, interest rate increases can weigh on dividend stocks – particularly those of the high-yield variety – but the reason why this time could be different is because bond yields are likely to remain low on an absolute basis.
“While other higher-yielding dividend strategies exist, they often come with higher risk. The S&P 500 Dividend Aristocrats, however, tend to exhibit lower risk by including only companies that have increased dividends for at least 25 consecutive years, while still delivering higher yields than the benchmark,” concludes S&P.
Bottom line: At the end of last year, the Aristocrats yielded nearly 100 basis points more than the S&P 500 and offer better income and total return prospects than many fixed income strategies