Want income? Look beyond the old reliable dividend stocks

  @Money January 22, 2014: 4:54 PM ET
income utility

In the 2013 rate spike, traditional high-yielding utility stocks stumbled -- returning a 7% loss.

NEW YORK (Money Magazine)

What's up with dividend stocks? When rates on Treasuries rose last year, traditional high-yielding stocks -- utilities, telecom, and real estate -- tumbled, even as the overall market gained ground.

One reason for the slide: As bond payouts have risen, high-yielding stocks that were being used as fixed-income substitutes are no longer as attractive. The other problem gets back to why the Fed floated the notion of beginning to pull back its stimulus policy in the first place: The economy is doing better.

How they fared in the 2013 rate spike
Yield Total return
Telecom 4.9% -9.5%
Utilities 4.1% -7.0%
Real estate 3.3% -13.1%
Energy 2.3% 4.5%
S&P 500 2.1% 3.9%
Info tech 1.7% 8.3%
Industrials 2.0% 6.5%
NOTES: Yields as of Dec. 12; total return from May 1, 2013, to Sept. 1, 2013. SOURCES: S&P Capital IQ, MONEY research

As that happens, classic high-yielding but slow-growing stocks will underperform more economically sensitive ones in sectors like energy, tech, and industrials. Trouble is, you won't find utility-like yields among growth-oriented companies.

1. To do better today, venture overseas

The best income opportunities are beyond our shores. European stocks are 25% cheaper on average than U.S. shares, their yields are higher, and the leading economies are showing signs of emerging from their long malaise.

How to invest: The Vanguard FTSE Europe ETF (VGK) currently yields 3.1%, a full point more than the S&P 500. Beaten-up emerging-market stocks pay even more.

Related: Invest in innovation - 5 stocks

Jeff Layman, chief investment officer at BKD Wealth Advisors, uses the WisdomTree Emerging Markets ETF (DEM) (3.95% yield) to invest in high-growth economies that can pack plenty of volatility: "We like the bird-in-hand approach to investing in that part of the world. Getting a 4% income payout right now strikes us as attractive."

2. Pair dividends with the promise of growth

With high yielders vulnerable as rates rise and high growers paying measly yields, you need a fresh approach. Look for stocks with better-than-average yields and strong dividend growth, says Josh Peters, editor of Morningstar DividendInvestor.

Related: Top stock picks from top pros

A reliable income cushion tends to reduce overall portfolio volatility; dividend growth gives you the prospect for rising income over time.

2014 economy will 'return to normal'

How to invest: The five stocks below, says Peters, are quality companies with above-average yields and the capacity to raise their dividends.

A moderate to low payout ratio -- the percentage of earnings that goes toward the dividend -- means room to grow; the long-term average for the S&P is 52%, but for sectors like utilities and real estate, the ratio tends to be much higher. Peters expects Chevron's recent spending on new energy sources to drive up cash flow, making it likely the energy company can keep its dividend growth.

Related: Winning at investing made simple

Fund Alternatives: SPDR S&P Dividend ETF (SDY), a MONEY 50 fund (2.4% yield) has only 20% of its assets in the most interest rate sensitive sectors. Vanguard High Dividend Yield Index ETF (VYM) (3.3% yield) has just 14% invested in rate-sensitive sectors.

More strategies on investing for income:
Bonds: Where to find higher yields
Cash: Find risk-free ways to earn more To top of page

Send a letter to the editor about this story to money_letters@moneymail.com.


The picks
Stock (ticker) Yield Projected dividend growth Payout ratio
Chevron 3.2% 8.5% 31%
Clorox 2.9% 7% 61%
Intel 3.8% 6.5% 49%
McDonald's 3.3% 8% 56%
Unilever PLC 3.5% 8% 60%
S&P 500 2% N.A. 33%
NOTE: N.A. is not applicable. SOURCE: Morningstar DividendInvestor
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