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Investing Specialists

The Courage Only Dividends Can Provide

You don't need to despair in down markets.

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Given the strong start we saw to the stock market in early 2007, this has been a surprisingly tough year--especially for income-oriented investors. Some overvalued and/or risky stocks have come down with good cause, but in general, fear and volatility--not value--have been firmly in charge. And nowhere have the beatings been more severe than in the financial-services sector, an area known for high dividend yields.

But has 2007 really been so bad after all? It all depends on what you choose to measure. The holdings of the two model portfolios I manage for income, Dividend Builder and Dividend Harvest, have chalked up 46 dividend increases with not even a single cut. These dividend hikes have grown the combined income of these two portfolios by more than 7%--this in addition to an aggregate yield that should hit 5% for the year. Sure, many of my recommended stocks have seen price declines this year. (With six banks and several other financial stocks in my roster of 29 recommendations, there's no real surprise there.) But as long as my income is safe and continuing to grow, the fundamental value of these accounts is rising, not falling.

Why can I be so pleased with a tough market? My secret is no secret; it's courage--the kind of courage only dividends can provide. Of all the indicators that an investor can anchor upon in pursuit of profits, only dividends provide more than a mere yardstick. Dividends provide cash for investors to use however they see fit--for living expenses, for luxuries, for reinvestment into additional dividend-paying shares. Rising dividends provide evidence that the business paying them is solvent, growing, and committed to rewarding shareholders for the use of their capital. And with income offsetting the need to sell in order for the investor to generate cash, current prices are greatly diminished in importance. I strongly believe this subtle shift of emphasis leads directly toward better investor outcomes.

Josh Peters, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.