Jim Cramer is touting a "new way" to generate yield. Actually, there is nothing "new" about it. Cramer believes investors should own dividend-paying stocks because of the low interest rates being paid by money market accounts and CDs. According to him, "everyone should own at least one high-yielder, and those of you who are nearing or in retirement should own many more."
In his search for a "new way," Cramer recommends buying Aviv REIT (AVIV:NYSE), which "many estimates" suggest could yield "around 5 percent."
Should you follow Cramer's advice and load up your portfolio with a bunch of dividend-paying stocks? Should you concentrate your dividend-paying portfolio on Aviv REIT? Not if you understand the underlying data, which is ignored by Cramer.
As a long-term investment strategy, concentrating your portfolio on dividend-paying stocks has many negatives. I discussed this issue in a previous blog post. Many stocks don't pay dividends now but may do so in the future. If you screen out stocks that don't pay dividends, you may miss out on stocks that could appreciate in value and may pay future dividends.
Just because a stock pays a dividend does not mean it is a good investment. Examples abound, but Eastman Kodak, Kmart and Dana Corp are all stocks that paid dividends and declined very significantly in value.
Cramer's "new way" to generate yield conveniently ignores risk. If we experience another market correction like the one we had in 2008, dividend-paying stocks would fall in value (like other stocks). In 2008, some companies that were paying dividends cut or eliminated them.
Focusing on one stock (like Aviv REIT) because it pays dividends exposes you to significant additional risk. The expected return of any stock is the same as the index to which it belongs, but the risk is significantly higher. The fact that the stock pays a dividend does not compensate you for the additional risk.
Finally, Cramer's recommended strategy makes it appear that high-dividend stocks are comparable to high-quality bonds, but with the added benefit of a higher yield. This is fundamentally wrong. There is no free lunch in investing. Higher yields invariably mean more risk. As my colleague Larry Swedroe noted in a blog post, the volatility of high-dividend stocks was more than three times higher than the volatility of investing in five-year Treasury notes measured for the period 1952 to 2009. Swedroe concludes: "Nothing in the historical data suggests high-dividend strategies are an appropriate substitute for high-quality fixed income or are the best way to gain exposure to value stocks."
Instead of adopting Cramer's "new way" to generate yield, you would be better advised to invest in a globally diversified portfolio of low-management-fee index funds, with a tilt towards small and value stocks. As I discuss in my book, "The Smartest Portfolio You'll Ever Own", research demonstrates that increasing the expected return in your portfolio is most efficiently implemented by increasing your exposure to stocks and not by varying the term or credit risk of bonds in your portfolio, or by investing in dividend-paying stocks.
Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His latest book, 7 Steps to Save Your Financial Life Now, was published on Dec. 31, 2012.
The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.
More From US News & World Report