While a growing number of investors are seizing on dividend stocks to build income streams, financial experts warn that stocks that pay high dividends can’t replace bonds in your portfolio.
The purpose of bonds is to provide stability in a portfolio. Treasuries have a negative correlation to stocks during market downturns, notes Michael Finke, a professor of wealth management at the American College of Financial Services. If stocks tumble, their prices tend to increase.
But investors who’ve replaced bonds with dividend stocks won’t have this ballast, as the share prices of dividend-paying companies could drop along with the market. What’s more, if things get really tough, the companies may reduce or eliminate their dividends, hitting investors with a double whammy.
Consider the 2007-09 recession, says Larry Swedroe, chief research officer at Buckingham Strategic Wealth, when the
Vanguard High Dividend Yield ETF
(ticker: VYM) returned a negative 51.7%, slightly worse than the S&P 500 stock index. “High-dividend-paying stocks got crushed,” he says.
Investors shouldn’t view stock dividends as income. Swedroe says. “Income increases your net worth. Dividends do not,” he says, calling it the financial equivalent of selling a portion of your stock portfolio.
Finke echoes this view. “A dividend is essentially a forced sale of a portion of your stock portfolio because your stock goes down the day it pays a dividend,” he says.
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