By: Jeff Bullock
In Star Wars: Return of the Jedi, one of the great scenes, and oft quoted lines in pop culture occurs when General Ackbar, the Rebel commander, is leading his fleet into battle against The Empire. Shortly into the attack he realizes they miscalculated one aspect of their plan and have unknowingly fallen right into the hands of their foe. It’s at this moment that General Ackbar exclaims, “It’s a trap!”
Many traps exist when you set out to invest your money. One trap, in particular, can be found when choosing an equity dividend strategy. Many investors who want income, while still maintaining equity exposure, turn to dividend strategies to fill this need.
As an investor, we believe you need to be careful, however, to find the right dividend strategy because many of these that look appealing on the surface, may actually have subtle traps under the hood. Below are three approaches to be aware of:
- High Dividend Yield but Low Dividend Growth: This approach is the biggest “gotcha”. They look great on the surface with a high dividend yield, but the underlying companies generally have a poor history of growing their dividend at any substantial growth rate. A strategy like this feels good at the outset, but often disappoints over the long run.
- Average Dividend Yield and Average Dividend Growth: To use a worn-down cliché, these strategies are a dime-a-dozen. An approach like this will bundle together a bunch of average dividend-paying companies that have an average dividend growth history. The results for the asset class are usually, average.
- Above Average Dividend Yield and Above Average Dividend Growth: Welcome to the land of dividend unicorns. These are the highly disciplined strategies that focus on cash-heavy, low debt companies, who have a long history of not only paying dividends (think decades), but also increasing those dividends every year. There is no instant gratification with these strategies, but years down the road they pay off due to their high dividend growth rate. This is where you want to be.
In the epic words of General Ackbar, “It’s a [dividend] trap”! Not all dividend strategies are created equal, but finding the right one, can make all difference years down the road.
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