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Don Dion's Weekly ETF Blog Wrap

Avoiding Dividend Cuts
6/11/2010 11:42 AM EDT

As if things weren't going badly enough for BP (BP) investors, the embattled company is now considering cutting its dividend to ease anger caused by the spill. While the story of this dividend-splicing might be the most noticeable to investors today, it's not the first time that shareholders have been let down by dividend-paying investments that suddenly become less attractive.

A series of disasters (both natural and manmade) have ushered assets to the sidelines and helped to make dividend-paying companies an attractive alternative. There are very few places where investors feel like they have a chance of receiving reliable income, and with rates so low, high-dividend companies are one of those few havens.

The problem with high-dividend firms is that they often are on shaky ground. While an improving economy is helping to ease the risk of default, the status of high-dividend paying companies can often change rapidly. Investors looking to reap the rewards of high-dividend paying firms should approach the process with a strategy.

I recommend gaining exposure to the group through the iShares Dow Jones Select Dividend Index (DVY), a fund that I have owned for more than six months. Not only does DVY's structure inherently reduce security-specific risk, but the fund's methodology also helps to protect investors from companies that are prone to cut down dividends.

In order to be included in DVY's portfolio, dividend-paying companies must first have certain criteria:
  1. DVY is comprised of 100 of the highest-yielding dividend securities (excluding REITs) in the Dow Jones U.S. Index, a broad-based index representative of the total market for U.S. equities.
  2. Companies must have a current year's dividend-per-share ratio, which is greater than or equal to their five-year average dividend-per-share ratio.
  3. Companies must have an average five-year dividend payout ratio of 60% or less.
  4. Companies must have a minimum three-month average trading volume of 200,000 shares a day.
By testing for liquidity, consistency and level of dividend payout, DVY's methodology helps to protect against obvious pitfalls of dividend investing. By minimizing exposure to any single company, DVY's strategy also helps to protect against major blowups.

A strengthening economy is making high-dividend firms an increasingly attractive investment option. Rather than trying to pick and choose, gain exposure to the group through a solid ETF, such as DVY, that does some of the heavy lifting for you.

At the time of publication, Dion Money Management was long DVY.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.
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