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The Major Flaw of Dividend Income Plans

The total return investor probably holds a mixture of stocks and bonds, and the portfolio may only throw off about 2% in dividends. The total return investor is counting on portfolio growth to stay ahead of inflation and to cover the shortfall in annual income needed versus dividends received.

The dividend investor requires a 4% initial portfolio yield. This approach requires sufficient dividend growth to allow future distributions to keep pace with inflation. The major flaw with this approach is that there is nothing sacred about dividends and they can be decreased, thereby creating the necessity for the devout dividend investor to convert to a total return investor at an inconvenient time.

I have prepared the table below as a case study. It clearly illustrates that dividend investment strategies can and do experience severe declines in dividend payouts. The largest dividend ETF, iShares Dow Jones Select Dividend ETF (DVY), had a 31.4% reduction in dividends from 2008 to 2009. The 2010 per share distribution amount was 29.8% below the 2008 level.

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