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By Josh Peters, CFA and Jeremy Glaser | 04-29-2015 10:00 AM

Is Dividend Investing Right for You?

The predictable income and total return of a dividend-stock portfolio is suitable for retirees and savers alike, says Morningstar's Josh Peters.

Jeremey Glaser: For Morningstar, I'm Jeremy Glaser. As interest in dividends continues to rise, many investors wonder if that style of investing is right for them and how to build a portfolio of dividend-paying stocks. I'm joined today by Josh Peters--he is the editor of Morningstar DividendInvestor newsletter and also our director of equity income strategy--for some advice.

Josh, thanks for joining me.

Josh Peters: Good to be here, Jeremy.

Glaser: Let's start with whom dividend-investing is right for--what kinds of goals you should have in mind before you start dividend-investing. Who do you think should look at a strategy like this?

Peters: I think it's for anybody who eventually is going to need a stream of income for retirement, which is to say almost all of us. Maybe there are some people who have still got defined-benefit pension plans and that's going to take care of their retirement; but for most of us, we've been handed this really tough task that frankly they don't teach in school very much--certainly not to everybody--which is how do you put away enough money for retirement and then convert those savings into a flow of income? Dividends may not be the entire solution for either saving up for retirement or providing that stream of income while you're in retirement, but they are very well positioned to be a very large part of the solution for most people. And the opportunity to combine both the total-return aspect--the capital appreciation and inflation-hedge aspect that you get from the stock market--with the predictable income component that you can get elsewhere only from fixed income. And to do that simultaneously--have that portion of your portfolio hitting to both sides of the field--that's pretty valuable.

Glaser: But dividend-payers are a small slice of the market. How do you know that that's really where you should be focus on getting your retirement funds versus looking at maybe areas that are growing a little bit faster or companies that are kind of in a more nascent part of their growth cycle?

Peters: Sometimes, it really pays to take the dividend itself out of the equation and just look at the business in an income-agnostic way--which is to say, assuming that I am going to be a partner in this business for the long term, can I understand it? Does it engage in a business activity that I'm comfortable with--that I can see and have some confidence predicting over a very long period of time? Is the balance sheet strong? Or is this just kind of a fly-by-night business that's going to fall apart when the economy does or when the stock market goes down? Is management allocating capital effectively? That's where the dividend starts to come back into the conversation. Is it providing at least some growth? Because there are very, very few stocks out there that you could justify owning just on the basis of the dividend itself. You really need that growth. You need quality. You need economically defensive attributes, I think, for a large portion of your portfolio.

Now, some investors are much more entrepreneurially minded, and they want to find the next Facebook (FB) or the next Google (GOOGL). That's fine. It's fine for some people to do that with just a portion of their portfolio. But when you look at the kinds of businesses--well established, well financed, well managed, providing a direct shareholder return. And then you layer on the practical advantage of collecting that dividend and either reinvesting it or using it to fund withdrawals. All of a sudden, it turns out these are the kinds of companies you'd probably want to invest in any way because of their risk characteristics, because of their understandability. I, for one, like to think of Apple (AAPL). Apple pays a dividend now. They just raised it again. But an Apple with a dividend is not the same as a General Mills (GIS) with a dividend. I don't have any real confidence in an outlook I might prepare for what their market share is going to be in something like smartphones and the margins associated with that even in five years.

General Mills: I'm pretty sure they're still in the Cheerios business in 50 years. So, when you start thinking about those long-term relationships you need to have with a company you are going to invest in in order to drive your portfolio's results over a long period of time, all of sudden those more-predictable defensive businesses, even if they don't have the big growth component alone, they've got the total return and the risk characteristics that I think you want at the heart of your portfolio.

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