With the fiscal cliff fast approaching, investors must decide what to do with their equities, including dividend-paying stocks. These are not easy decisions, since so much depends on what happens in Washington. Here are my tips for how investors should evaluate fiscal cliff risks, especially with regard to holdings in dividend-paying stocks.
How Worried Am I about the Fiscal Cliff?
I would start by considering my overall level of concern that the U.S. will go over the fiscal cliff. What if I believe that the odds are high that no deal will be struck and, as a result, that automatic tax increases and spending cuts will occur at the beginning of 2013? In that case, I would consider selling equities, because experts say this scenario could push the economy into a recession and, as a result, the outlook for the stock market in the next few months (or longer) could be bleak.
Dividend Stocks: a Special Category
However, I believe that decision about whether to sell dividend-paying stocks is more difficult, and I would consider a number of factors before acting, even in the face of the fiscal cliff.
I could miss out on income if I sell dividend payers too soon since many companies are announcing special dividend payments ahead of an anticipated tax increase on dividends in 2013. In fact, according to Bloomberg, 59 companies in the Russell 300 index announced special dividends from September through mid November 2012 (www.bloomberg.com/news/2012-11-19/special-dividends-surge-fourfold-as-tax-increase-looms-in-u-s). Also, some companies are accelerating payments of regular dividends into 2012 from 2013 so that investors can take advantage of today's low tax rates.
Benefits of Dividend Payers
I would weigh the near-term risks to the economy and stock market relative to the benefits associated with owning dividend-paying stocks and my long-term investment goals. For example, historically, dividends have contributed a significant portion of stock market returns (bonds.about.com/The-Role-Of-Dividends-In-Total-Return). Also, the yields (annual dividend rate/share price) on many dividend-paying stocks currently are very attractive versus what investors can earn on alternative investments such as certificates of deposit.
Individual Stock Characteristics
I would also evaluate my dividend-paying stocks individually. For me, the best candidates to retain, even if I am concerned about market risks related to the fiscal cliff, are high-quality, established companies that have a history of dividend increases, healthy balance sheets and strong cash flow. If they are in industries that are not overly sensitive to changes in economic activity, that would be even better.
Investment Time Horizon
Finally, I would consider the time frame for my investments in dividend-paying stocks. If it is long term, I might be better off holding onto some quality, reliable dividend payers even at the risk of a near-term market decline. After all, market timing is notoriously difficult to get right and, if I sell my dividend stocks and the fiscal cliff issues are resolved, instead of avoiding losses, I might miss out on big gains.
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