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By Timothy Strauts | 05-29-2014 10:00 AM

Dividends Great for Long Term, but Beware Rising Rates

High-dividend-paying stocks tend to outperform all other equities during long time horizons, but they are the worst performers when interest rates increase.

Tim Strauts: Today we're going to look at how dividend stocks have performed in different interest-rate periods. In this chart, you can see we've broken up the equity universe into four buckets. The highest 30% bucket is the 30% of stocks with the highest dividend yield, going all the way down to the no-dividend bucket of companies that pay no dividends.

Then we looked at interest rates, and we looked at the period between 1927 and end of 2013. In the falling-interest-rate group, we took the 20% of months that had the largest decrease in interest rates. The neutral group is the 60% of months that were in the middle. And then [there is rising rates group] which is the 20% of months that had largest increase in rates.

What we found is that over a full period of 1927-2013, that high-dividend stocks had the highest returns. But in the periods of rising interest rates they actually were the worst-performing category, and actually companies that didn't pay a dividend outperformed by a substantial margin. Although dividend stocks may be a great investment for the long term, if rates rise quickly they may perform poorly.

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