What is a Good Dividend Yield?

Dividend yields have a bit of a "Goldilock's porridge" quality about them. Investors have to try different yields while searching for the ones that are just right. Pick one that's too low, and you'll be risking your money and not getting paid for taking on that risk. But pick one that's too high and you could get seriously burned.

Too Low

Investors love dividends. And they have every reason to. A dividend can be, among other things, evidence that a company is:

1. financially secure; 
2. confident about future sales trends; and 
3. willing to share that stability and success with it's shareholders

But just paying any old dividend doesn't automatically qualify you as a good dividend stock.

Consider the case of Halliburton (NYSE:HAL), an oil and gas company with a market cap of over 40 billion. Halliburton's current yield is 0.75%, which is less than what you can get from a 2 year U.S. treasury bill. One of these investment options is backed by the full faith and credit of the U.S. government, and the other one is not (probably).

To qualify as a good dividend yield, it has to compensate investors for the extra risk of owning stocks instead of bonds or bank CDs, so the yield shouldn't be too low.

Too Steady

Consistency is a prized value in dividend stocks. So much so that the S&P 500 has a special class of dividend payers called dividend aristocrats which have raised dividends for at least 25 consecutive years.

But consistency can cut both ways. Take a look at Merck (NYSE: MRK), a pharmaceutical company with a mega-market cap of over 100 billion. It currently sports a hefty yield of over 4.5% which is no small potatoes when 10 year treasury bonds are paying around 3.75% and most bank savings accounts are at less than 1%.

But as with so much of investing, the important aspect of the dividend yield is all about the future, not the present. And that's where Merck comes up short. The company has been paying the same exact dividend for over six years, without a single hike since September of 2004! That's not the kind of consistency that dividend investors hope for. To qualify as a good dividend yield, it has to be growing.

Too High

In early 2008, Harley Davidson (NYSE: HOG) had a dividend yield of $0.33 per share, or over 6%. Investors who were selling Harley stock for fear of what the recession would do to motorcycle sales were right to keep the stock price down, and the dividend was slashed by 70 percent in the next quarter!

To be a good dividend yield, it must be sustainable and shouldn't be temporarily inflated by a low stock price. In other words, it shouldn't be too high.

Just Right

That puts the sweet spot of dividend yields these days at around 3-5 percent. There are plenty of large cap companies paying dividends in this range which have been raising their dividends over the last five years. Running a screen for these metrics yielded about 40 stocks for me. Here are a few picks from the bunch:

Unilever (NYSE: UL)

Market Cap: 84 Billion

Yield: 4.75

Dividend Growth Rate (5 year average): 17%

McDonald's (NYSE: MCD)

Market Cap: 80 Billion

Yield: 3.21

Dividend Growth Rate (5 year average): 29%

Clorox (NYSE: CLX)

Market Cap: 9 Billion

Yield: 3.23%

Dividend Growth Rate (5 year average): 14%

 

Disclosure I am long CLX, MCD and UL shares.

Closed-End Funds Can Open Profit Potential, funds for income, diversification

Most investors are familiar with mutual funds and exchange-traded funds (ETFs), but fewer are familiar with closed-end funds.

Despite being older than both mutual funds and ETFs, closed-end funds (CEFs) offer some distinct advantages for long-term investors who want to diversify their holdings.

Despite their name, CEFs are always open to new investors, even after the fund has started to trade. “Closed-end funds” derived that name because they offer a finite number of shares, so the amount of shares is limited or closed. As a result, a CEF does not continuously offer new shares. When a new investor wants to buy into the CEF, they will see a continuous bid and offer throughout the trading day based on the current market price of the CEF’s holdings. Since the CEF has a limited number of shares, its price is based on market demand.

In contrast, the price of a mutual fund is based on the net asset value (NAV) of its holding as determined at the end of the trading day. Another major difference between mutual funds and closed-end funds is that mutual funds can continuously offer new shares to new investors. In theory, a mutual fund can continuously grow to accommodate new investors. CEFs can not since they only offer a finite number of shares.

Aside from how their share price is determined, CEFs and mutual funds have many similar features: CEFs can invest in bonds, real estate, growth, small cap, value and international stocks. They also can use leverage, so some closed-end funds invest in real estate and other assets which require the use of borrowed money. Investors also buy into the CEF at par, so subsequent prices can go lower or higher.

Closed-end funds differ from exchange-traded funds because they provide active management, as opposed to the indexes that underlie ETFs.
One of the Oldest Fund Investments

There are about 750 CEFs offered, according to Brian M. Smith, director of the Closed-End Fund Association in Kansas City, Mo. Some of the oldest CEFs – General American Investors (NYSE: GAM), Adams Express Company (NYSE: ADX), Tri Continental (NYSE: TY) — started in 1929, Smith said. That was well before the introduction of mutual funds, which trace their origins to the Investment Company Act of 1940. CEFs also are more heavily regulated than mutual funds, Smith said, since they are registered both as corporations and mutual funds. Today, many of the same large companies that offer mutual funds — Royce Funds, Gabelli Funds, Nuveen , BlackRock — also use their investment expertise to offer CEFs.
Risks and Rewards of Closed-End Funds

CEFs are usually appropriate for people seeking income, and for investors “looking for the opportunity of greater return, who can also assume greater risk,” Smith said.

Since CEFs can invest in leveraged investments, such as non-liquid assets like a shopping center, and trade at a market value, they often trade at a discount, Smith explained. When this occurs, the average closed-end fund can be sold for less than the value of the assets it already owns. As the CEFs discount narrows, it creates greater returns for its investors.

Investors who purchase CEFs pay commissions which are no different than those in the mutual fund industry, Smith said. They can be bought at a discount from a broker-dealer, discount broker, financial adviser or as part of an auto-direct investment program,

Since CEFs can invest in leveraged assets, they are typically not offered in 401(k) plans, Smith said.

Disclosure I am long 18 closed end funds none of which are mentioned here.
My favorite Closed end fund research site is CEF CONNECT. 

What Happens When You Over Contribute into IRAs?

You always hear that you need to “Save, Save, Save” for retirement, but is it really possible to save too much? When it comes to contributing to your IRA, it can.
Individual Retirement Accounts (IRAs) have annual contribution limitations that indicate how much you’re allowed to contribute. Anyone, regardless of income level can contribute to Traditional IRAs, but in addition to having a maximum contribution amount for a Roth IRA, you’ll also need to have annual income within limitations in order to contribute, at all.
It’s always best to prevent over contributions into IRAs, whether you have a Roth IRA or a Traditional IRA, so consult a tax professional if you have any questions about your allowed contribution amounts each year. If you do contribute more than you are supposed to, also consult a tax professional for advice on how to remove the overage to avoid penalties and tax implications.

Roth IRAs

For Roth IRAs, you can contribute $5,000 per year if you’re under the age of 50 and as much as $6,000 annually if you’re over the age of 50. The contribution limitation is adjusted based on your annual adjusted gross income, however. If you make between $105,000 and $120,000 a year as a single tax filer, you can make partial contributions based on the amount you earn. If you are married and make more than $166,000 but less than $176,000 you can also make partial contributions. If you make more than the stated annual income amounts, you’re not allowed to contribute to an IRA at all.

What if You Contribute Too Much in a Roth IRA?

If you contribute more than you are allowed into a Roth IRA, you can withdraw the amount over the limit by the date you file your income tax return. If you fail to withdraw the amount you’ve over contributed, you will have to pay 6% excise tax on the overage amount (and any earnings it has made).

Traditional IRA

Contributes to Traditional IRAs are tax deductible, and directly reduce the amount of taxable income you have in the year that you make your contributions.
Like a Roth IRA, you can contribute up to $5,000 per year, although if you earn less than $5,000 in a year you’re allowed to contibute 100% of your earned income (whichever is less). If you’re over the age of 50, you can make catch-up contributions of $1,000 for years 2009 and 2010.

What if You Contribute Too Much in a Traditional IRA?

If you contribute more than you are allowed into a Traditional IRA, you can withdraw the excess contribution before you file your income taxes without penalty. If you don’t realize the over contribution until after you’ve filed your taxes, however, you will withdraw the excess amount and be penalized 6% for each year the money remained in your account when it should not have been there. You’ll need to file IRS Form 5329 when you withdraw your funds and it can be treated as an “early withdrawal”. Under Traditional IRA early withdrawal rules, you could be taxed twice on the withdrawal.

How Does this Happen?

The most common time I see someone over contribute to an IRA (Roth or Tradtional) is when they have IRA’s at two different locations; for example, a bank at a brokerage firm. You have to understand that just because you have multiple IRA’s at different financial institutions doesn’t mean you can contribute $5,000 to each. That same rule applies to having both Traditional and Roth IRA’s.
Another time I see this occur is when someone has automatic contributions being directly deposited into their IRA. Either they forget the amount or just lose track of how much they’ve contributed (you should be always be able to check with your IRA custodian to see how much you’ve contributed). In the event that this occurs, you can always apply the excess contributions to a future tax year so as long as the amount does not exceed the contribution limit for next year, too. Keep in mind though that the 6% excess tax may still apply.

Keep Track of How Much You Put Into Your IRA

It goes without saying that the easiest way to prevent putting too much into your Roth and Traditional IRA’s is to keep track of how much you’ve added. As I’ve mentioned before, even if you lose track, your IRA custodian should have a record of how much you’ve contributed for the current tax year.

Disclosure I have a IRA at sharebuilder.com

An ETF Trend-Following Plan For All Seasons

It’s hard to believe that the S&P 500 Index has been flatter than a pancake for the past nine years. It’s had its ups and downs, but when you connect the dots, it went virtually nowhere.
It’s even harder for index investors who relied on this large-cap benchmark to grow their retirement savings. To think, a portfolio with $100,000 allocated to the S&P 500 hardly budged at all. That’s a lot of wasted time and missed opportunity.

That’s why we advocate following trends and actively managing our portfolios using exchange traded funds (ETFs). Whether the broad market travels sideways or falls, a trend is always in the making.
Actually, the term “sideways market” is somewhat misleading. There’s plenty of market activity, but it’s in the form of a sharp downward move, and then a slow recovery period back to its original price level. Only the best and luckiest of timers can get in at the lows and exit at the highs. Otherwise, it can be a very frustrating experience, even for seasoned investors.

Surviving the Dry Season
A quick review of history shows that there have been dry spells in the market lasting 10 years or more. For example, an investment in stocks making up the S&P 500 Index during the periods from 1929 through 1942 (13 years) and 1966 through 1982 (16 years) would have amounted to no more than a break-even investment.
In this most recent nine-year sideways move, the S&P 500 has fallen in value an average of 0.37% per year, a far cry from the stock market’s historical average annual returns of 10% to 12%.
Many financial advisors focus on your timeframe for growth, but it doesn’t matter if you have five years or 25 years left until retirement. You can’t afford to let your investments sit idle for nine years. Worse yet, an idle investment doesn’t take advantage of the beauty of compounded growth.
No matter what the cause, the market’s recent non-action underscores the inherent danger of the buy-and-hold strategy. Sure, the markets will likely rebound eventually, but that will be of little consolation to investors who need their money now for retirement, or who may have bailed out of the markets at or near the bottom.
The volatile jerks during a sideways market often make investors believe that a market rally has taken hold during highs, only to experience disappointment when yet another sharp downturn occurs. Some who can’t stand the fluctuations get out of the market and sit on the sidelines, often without any plan for how to get back into the market later on.

Countering Volatility With ETFs 

So what can an investor do? Well, an ETF investor who follows the trends and sticks to a sell discipline has a whole bunch of options.
We take advantage of trends that have developed in asset classes, sectors and global regions. Increasing allocation to these areas work well as long as the trend remains intact.
With the growing list of available ETFs and ever-changing trends, we are convinced more than ever that a disciplined investment strategy is required to enhance portfolio returns, diversify and reduce downside risk.
Your strategy, like ours, should be to stick to a plan and not let emotions get involved. Once you start thinking with your heart or gut, it can be hard to kick-start your logic. Even neutralizing emotions will serve any trader well.
You need to know what to buy, when to buy and, as importantly, when to sell.

Three Main Rules

Here are three rules that should help keep most ETF investors out of trouble:

1. Maintain an 8% stop-loss on your ETFs.
2. Keep an eye on the trend. If your ETF declines below its 50-day average, that’s not a good sign. If the same ETF declines below its 200-day average, sell.
3. Don’t chase markets that are too hot. The last time many world markets and industry groups collectively hit new highs was in 2000. You know what happened then – the boom went bust. Keep your emotions in check.

The Business of Buying and Selling
The first, and perhaps most important screening process for ETFs is knowing the 200-day moving average of each candidate—and where it stands in relation to it. Trend lines are so key that you should only invest in ETFs trading above their 200-day moving averages. You can find this information by clicking on the “basic technical analysis” in the sidebar of any fund information page at finance.yahoo.com.
We look for uptrends, and then examine those trends using fundamental analysis. Once a position is entered, we stay in the investment until the trend turns negative, declining below its trend line.
In some cases, where trends have moved steeply to the upside, the corresponding ETF may be more than 10% above its moving average. In those cases, we impose an 8% stop-loss. If you buy an ETF trading 15% above its 200-day moving average, it’s best to sell if it drops 8% from a recent high. That way, you preserve as much profit as you can.
You must remember that over time, the stock market and individual securities follow general trends and these trends are identifiable. The idea is that you want to be more fully invested in stocks when the market is above its long-term trend line (200-day moving average). And you want to be safely positioned when the market is trending downward.
Below is a chart of the S&P 500 (NYSEArca: SPY) with its 200-day moving average. You can see that it traded above that mark between 1995-mid-2000, at which point the bear market replaced the bull market. The S&P 500 stayed below its 200-day moving average and kept us out of the market from mid-2000 to mid-2003, then climbed back above from mid-2003 to mid-2004.

How often we pull the trigger on building or unwinding a position all depends on the ETF and where that ETF lies in relationship to its own moving average and its performance off the high.

Looking at the iShares FTSE/Xinhua 25 (NYSEArca: FXI) chart, for example, if an investor bought in at the beginning of September 2007, they should have sold in the beginning of November 2007 when the ETF fell 8% off of its high. This would have meant a gain of about 25% and would have saved the position from falling further, as it is now about 40% off of its high. By following a sell discipline, one could protect more of the gain and avoid greater losses.

Resolve To Protect and Profit
Momentum can certainly turn on a dime. Just look at the health care sector in 1991 as an example. It was up 50% for that year, but the following year it was down 19%.
Whatever trend you’re following, just be sure to take a disciplined approach and remember to follow through with your strategy.

• Resolve to stick to your discipline. We know the past year has been rocky, and it is hard not to get emotional. We can’t predict the future, so we don’t know what’s in store for the rest of 2008. One way to avoid pulling every last hair out of your head in frustration over the uncertainty is to have a plan and adhere to it no matter what.
• Resolve to pay attention to the news. Political upheaval, major weather events and leadership changes are among the things that can indirectly affect your holdings. Don’t just isolate yourself to the business section.
• Resolve to pay attention to your investments. Are you coming up on a major life change, such as having children or entering the homestretch before retirement? Look at your portfolio and make sure it’s still working for you.
• Resolve not to invest in something simply because it’s “hot.” That’s the best way to get burned. Invest because it fits your needs, interests and your portfolio.

Exiting An ETF…Safely and Profitably

If an ETF falls below its 200-day moving average, or if it drops 8% off its high without going below its 200-day average, sell it. It’s a rigorous discipline and is applied to all asset classes, sectors and global regions where there is ETF representation. It’s clear-cut, and you know exactly what your risk is.
However, if you don’t have an exit strategy, then your risk tolerance may not be as well-defined. It takes a high tolerance and lots of patience to suffer 20% or more in losses that some sectors and regions have experienced a few times over the last several years.
While we are clear proponents of having an exit strategy, we understand that there can be some confusion when certain ETFs drop quickly and then climb sharply. There’s a chance you might have sold a position that declined further after you sold it but then rebounded.
In this case, don’t beat yourself up over lost opportunity. Just stick to your plan, have no regrets, never look back and keep moving forward.
When this happens, remember that you can treat the cash you have from previously selling an ETF as a “free agent.” This means that there’s no rule that says you must buy back the same ETF you sold if it’s performing well now. Shop around; see where new trends are developing. There might be a different ETF that’s even better for your portfolio now.
Sharp market movements and subsequent ETF declines can unsettle many investors. However, with an exit strategy and specific stop-loss points, the drops can be less stressful for you as it prevents small losses from turning into there-goes-my-house losses.
There have always been and will always be bubbles, and the only sure way you can protect yourself is to have an exit strategy always at the ready.
If an ETF you’re holding – whether it’s commodities or something else – drops below its trend line or falls 8% off its high, let it go, no questions asked.
A lesser stop-loss, such as 5%, could be too low since markets often have a 3% to 5% correction before they move on and hit new highs. If your stop loss is too low, for example, at 3%, you’re going to be buying and selling more frequently, racking up fees in the process.
Ultimately, that eats up your returns. You also won’t be able to fully take advantage of trends. Instead, you’ll be dealing with constant short-lived whipsaws. Sometimes there are volatile days in the middle of an overall uptrend, and it’s in your best interest to ride those out.
On the other hand, having a sell point that’s too high can also hurt you. Setting your sell point at 30% could mean that you lose a significant portion of money before you’re out. It also has you sitting in areas that might not be performing so well and missing out on areas that are trending up.

What If You Missed The Safety Boat?

What should you do if you missed the 8% drop, and you’re down much further than that? Missing the sell point creates the conundrum above. That’s when I recommend the following:

Sell 1/3 of your equity holdings and focus on the most aggressive positions—those that might be down 20-30% and trading 10-15% below their 200-day moving averages.

If those holdings decline by another 5-7%, consider selling another third.

Keep an eye on the 200-day average of these positions. As the trend lines continue to decline, there will be an excellent buying opportunity in the future when the markets eventually rebound.

Letting Go of a Winner Can Be Hard

It can be difficult to let go of a mover and shaker you’ve always had a soft spot for, but if you want to protect your money, you must. It’s like your parents always said when they were grounding you every other week: “This hurts me more than it hurts you.” But sometimes it has to be done for everyone’s good.
There are no guarantees that when you let a fund go, it’s not going to turn around and deliver the numbers again. But that doesn’t mean it won’t, either. It’s exactly why you have to remain as stoic as possible and stick to the plan and rationalize nothing.
What if you follow your exit strategy, and the ETFs you sell end up rebounding? Try this:

• Treat the newly available cash as “free agent” funds. Just because you sold an ETF doesn’t mean you’re obligated to buy it back when it rebounds.
• Look for ETFs that are above or rising above their trend lines.
• Look for ETFs with positive, relative strength. When markets rebound off a low, it’s usually those with the greatest momentum that enjoy sustained uptrends.

As you manage your own portfolio, you might feel a need to always have a set amount of money designated to a certain investment (i.e. small-cap, China or commodity). If this is the case, then the cash can be held until that certain investment goes above its 200-day moving average or gains 5% from its recent low.
With the recent volatility in the markets, we have seen some price swings in ETFs. One shouldn’t worry about the daily ETF price movement; having an investment plan is the priority. When there is a discipline in place, it can help guide investors through the volatile times.
If you’ve got nervous hands as your ETFs swing up one day and down the next, the best thing you could do is to just sit on them.
Removing the emotions from your investing is one of the smartest things you can do.
And, as we’ve said, having a strategy and removing your feelings from your money is especially timely, considering the ups and downs can make you feel sick.

The Anatomy of a Bursting Bubble—Here and Abroad

Investors and economists often use history as gauge for what might happen today and in the future. Could we have studied the onset of a 14-year bear market in Japan to predict the dot-com crash and subsequent bear in the U.S.? And, what do both events say about today’s economy and markets?
Let’s take a look back.
In the 1980s, outsiders perceived Japan as a utopia because its people had the highest quality of life and longest life expectancy. In addition, Japan was the world’s largest creditor and had the highest GDP per capita. Many Americans feared that Japanese-made robots would eliminate their jobs. With the economy booming and the stock market climbing, skyscrapers filled the Tokyo and Osaka skies, causing real estate prices to skyrocket as well.
Between 1986 and 1988, the price of commercial land in greater Tokyo doubled. Real estate prices soared so much that Tokyo alone was worth more than the United States. Between 1955 and 1990, land prices in Japan appreciated by 70 times and stocks increased 100 times over. Large-scale stock speculation led to worldwide mania. Investors all over the world clamored for Japanese shares. These euphoric investors believed in a perpetual bull market. Luxury goods were purchased in large numbers by the newly wealthy.
Unfortunately, all excessively good things must end. To cool the inflated economy, the Japanese government raised rates. Within months, the Nikkei stock index crashed by more than 30,000 points. The Nikkei crashed this far because its value was inflated on false hopes and hype, not solid financials. Japanese housing prices plummeted for 14 straight years. At its height, the Nikkei stood at 40,000. The Nikkei sank until its low of 8,000 in 2003.

Dot-com Déjà vu 

Back at home, we experienced a similar crash, but one not nearly as lengthy or devastating as that of Japan’s: the dot-com crash, which began on March 11, 2000 and lasted until Oct. 9, 2002. From peak to valley, the Nasdaq lost 78% of its value as it fell from 5046.86 to 1114.11.
The U.S. military created the Internet decades before “dot-com” became a household word. Vastly underestimating how much people would want to be online, it began to catch on in 1995 with an estimated 18 million users. Soon, speculators were barely able to control their excitement over this new economy. Today, 210 million people in China-alone go online, 50 million users shy of the United States.
The first holes in this bubble came from the companies themselves: Many reported huge losses and some folded outright within months of their offering. In 1999, there were 457 IPOs, most of which were Internet- and technology-related. Of those 457 IPOs, 117 doubled in price on the first day of trading. In 2001, the number of IPOs shrank to 76, and none of them doubled on the first day of trading.
Many argue that the dot-com boom and bust was a case of too much too fast. Companies unable to decide on their corporate creed were given millions of dollars and told to grow to Microsoft size by tomorrow.
Unfortunately, economic and “unanticipated” risks will always be there. Investors hate uncertainty, and since we can’t always identify them in advance or eliminate them, there will be times when they affect the investment markets negatively.
If you follow a buy-and-hold strategy, you leave your portfolio vulnerable to any number of unknowns: oil spikes to $200/barrel, the Middle East erupts into war, The Fed makes a drastic move with interest rates. With an exit strategy, you’re prepared to cut losses or pocket profits when events send the markets lower.
Risks Without Reward

During the 1990s, many investors believed that the stock markets would produce returns of 20% (or more) per year indefinitely, which was a part of the herd mentality back then. Same goes for the late 1970s and early ’80s, when investors thought bank certificates of deposit and fixed annuities would always have double-digit yields—two assumptions that were clearly wrong.
If your expectations for portfolio returns are too high, there is a very good chance your financial goals will not be met. And more importantly, this can lead to saving too little money to meet your retirement goals. Unfortunately, this can also lead to investing in securities and strategies that are far too risky in order to try to “turbo-charge” the returns.
On the flip side, there are investors who invest too conservatively and risk losing purchasing power to inflation. Investing too conservatively can also raise the odds of not meeting investment goals, as well as the risk of outliving your assets.
So, we find ourselves at another crossroads in the markets. Real estate exuberance, based on inflated prices, has gone sour along with values; financial institutions have turned from princes to frogs in a matter of months; consumer debt is at all-time highs, and investors grow increasingly frustrated with the lack of opportunities the current stock markets offer.
But investors who combine the flexibility, diversity and ease-of-use of ETFs with a disciplined buy and sell plan don’t have to fret about all the outside influences on the markets. You can turn a deaf ear to financial hype and keep emotions out of the investing equation.
That’s because the simple, technical indicator—the 200-day moving average—tells us precisely when to buy and when to sell. Even when it seems like the entire market is down, you can count on there being a trend-bucking ETF ripe for the picking.

What the Opportunities Look Like

The S&P 500 and Dow have been trading below their 200-day moving averages for all or most of the year. Meanwhile, gold, oil, steel, and agriculture ETFs have traded above their respective 200-day marks and offered investment opportunities in 2008.

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 Disclosure I am Long SPY.

Due Diligence On Dividends

Many beginning investors do not understand what a dividend is, as it relates to an investment, particularly an individual stock or mutual fund. A dividend is simply a payment to shareholders, typically of a publicly traded company. A dividend payment is a payout of portion of a company's profit to eligible stockholders.

However, not all companies pay a dividend. Usually, the board of directors determines if a dividend is desirable for their particular company based upon various financial and economic factors. Dividends are commonly paid in the form of cash distributions to the shareholders on a monthly, quarterly or yearly basis. Shareholders of any given stock must meet certain requirements before receiving a dividend payout, or distribution.

You must be a "shareholder of record" on or subsequent to a particular date designated by the company's board of directors in order to qualify for the dividend payout. Stocks are sometimes referred to as trading "ex-dividend", which simply means that they are trading on that particular day without dividend eligibility. If you buy and sell stock on its ex-dividend date, you will not receive the most current dividend payout. Now that you have a basic definition of what a dividend is and how it is distributed, let's focus in more detail on what more you need to understand before making your investment decision.

How Dividends Are Calculated
It may be counterintuitive, but as a stock's price increases, its dividend yield actually decreases. Many novice investors may incorrectly assume that a higher stock price correlates to a higher dividend yield. Let's delve into how dividend yield is calculated, so we can grasp this inverse relationship.

Dividends are normally paid on a per-share basis. If you own 100 shares of the ABC Corporation, the 100 shares is your basis for dividend distribution. Assume for the moment that ABC Corporation was purchased at $100/share, which implies a $10,000 total investment. Profits at the ABC Corporation were unusually high so the board of directors agrees to pay its shareholder $10 per share annually in the form of a cash dividend. So, as an owner of ABC Corporation for a year, your continued investment in ABC Corp should give us $1,000 in dividend dollars. The annual yield is the total dividend amount ($1,000) divided by the cost of the stock ($10,000) which gives us in percentage terms, 10%. If the 100 shares ABC Corporation was purchased at $200 per share, the yield would drop to 5%, since 100 shares now costs $20,000 OR your original $10,000 only gets you 50 shares, instead of 100. As illustrated above, if the price of the stock moves higher, then dividend yield drops and vice versa.

The Mechanics of Dividends
The real question one has to ask is whether dividend-paying stocks make a good overall investment. Dividends are derived from a company's profits, so it is fair to assume that in most cases, dividends are generally a sign of financial health. From an investment strategy perspective, buying established companies with a history of good dividends adds stability to a portfolio. Your $10,000 investment in ABC Corporation, if held for one year, will be worth $11,000, assuming the stock price after one year is unchanged. Moreover, if ABC Corporation is trading at $90 share a year after you purchased for $100 a share, your total investment after receiving dividends is still break even ($9,000 stock value + $1,000 in dividends).

This is the appeal to buying stocks with dividends: it helps cushion declines in the actual stock prices, but also presents an opportunity for stock price appreciation coupled with a steady stream of income that is dividends.

This is why many investing legends such as John Bogle, Warren Buffett and Benjamin Graham all espouse the virtues of buying stocks that pay a dividend as a critical part of the "investment" return of an asset. (Discover the issues that complicate these payouts for investors Dividend Facts You May Not Know.)

Risks to Dividends
During the financial meltdown in 2008-2009, all of the major banks either slashed or eliminated their dividend payouts. These companies were known for consistent, stable dividend payouts each quarter for literally hundreds of years. Despite their storied history, the dividend was cut.

In other words, dividends are not guaranteed, and are subject to macroeconomic as well as company-specific risks. Another potential downside to investing in dividend-paying stocks is that companies that pay dividends are not usually high growth leaders. There are few exceptions, but high-growth companies usually do not pay dividends to its shareholders even if they have significantly outperformed over the vast majority of all stocks over the last five years. Growth companies tend to spend more dollars on research and development, capital expansion, retaining talented employees and/or mergers and acquisitions.

For these companies, all earnings are considered retained earnings, and are reinvested back into the company instead of rewarding loyal shareholders. It is equally important to beware of companies with extraordinarily high yields.

As we have learned, if a company's stock price continues to decline, its yield goes up. Many rookie investors get teased into purchasing a stock just on the basis of a potential juicy dividend. There is no specific rule of thumb in relation to how much is too much in terms of a dividend payout.

The average dividend yield on the S&P500 companies that pay a dividend historically fluctuates somewhere between 2-5%, depending on market conditions. In general, it pays to do your homework on stocks yielding more than 8% to find out what is truly going on with the company. Doing this due diligence will help you decipher those companies that are truly in financial shambles from those that are temporarily out of favor and therefore present a good investment value proposition. (Explore arguments for and against company dividend policy, and learn how companies determine how much to pay out. Read How And Why Do Companies Pay Dividends?)

Conclusion
Dividends are really a discretionary distribution which a company's board of directors gives its current shareholders. It is typically a cash payout to investors at least once a year, but sometimes quarterly. Stocks and mutual funds that distribute dividends are likely on sound financial ground, but not always. Investors, however, should be aware of extremely high yields, since there is an inverse relationship between stock price and dividend yield and the distribution might not be sustainable. Also, stocks that pay dividends typically provide stability to a portfolio, but do not usually outperform high quality growth stocks.

Disclosure None

7 tips for investing in stocks

Investment experts always advise investors to stay away from 'junk' stocks. Warren Buffet once famously said "The only time to buy these (junk stocks) is on a day with no 'Y' in it."
Stocks can be as tricky a business for novice investors as they are for seasoned players. However, as Warren Buffet has always propagated, 'Right stocks at the right price' is the way to laugh your way to the bank. This means, avoiding all those 'junk' stocks and setting your sights only on the 'right ones'.

So how do we really separate the wheat from the chaff? In an age where Satyam [ Get Quote ] and Infosys [ Get Quote ] both ruled the roost at one point of time, how do we know which ones are the black sheep and which ones are not?

In this issue of women's weekly, we bring to you the fundamentals of choosing a stock from a long-term perspective:

Sound management

A sound management is like a captain of a ship. The onus of charting out the right direction in still waters and steering the company safely in troubled times lies on the management.

We would even go to the extent of saying that the way in which a management behaves, determines to a great extent, the long term success of the business. You don't want to be an investor in a company where the management takes money from the shareholders to fill its own pockets.

A case in point here would be Satyam. It promised its investors the moon. However, they soon had to settle for sleepless nights as the ugly truth of Satyam reared its head.

Investor mentality

Traders routinely buy and sell the same stocks within a time frame of a few hours. 'Investors', on the other hand, put money in stocks and hold on for a longer period of time, generally at least 2 to 3 years.

Develop an investor mentality. Adopt a long-term investment strategy. While looking at the quarterly results of the company, don't lose sight of the bigger picture. Invest for a longer duration which promises more returns and is not affected by daily market fluctuations.

Research shows that the shorter the duration of investment, the more are the chances of losing money. While, with long term investing, the chances of losing money are lesser.

Remember, the longer the investment period, the greater are the chances of making money.

Practical approach

Emotions need to be kept aside while dealing with stocks. Don't get emotionally attached to your investments. Your aim is to get maximum profits out of your stocks. It's immaterial if this is achieved through selling them, buying them or holding them.

Just because you are emotionally attached to the stock or just because the little voice inside your heart says, "Give it some time and things will work out just fine", does not mean that you have to hold on to a stock when it is destined to hit its nadir.

Consistently Proven track record

At the end of the day, it's all about numbers. Numbers can tell a story - you should just have an ear attuned to understanding their language. It makes sense to thoroughly investigate the company and its track record.

Consistency is the key. If the company is good, it will have a consistent performance. Its income statement will show consistent profits. Its annual reports will talk about the consistent dividends doled out. Ideally, the company should have a dividend history over the past 5 years and a dividend payout comparable with its peers.

In the case of 'growth stocks', the game changes a little. The company may not distribute its' profits as dividends; rather, it would invest the profits back into the venture for future growth. However, all said and done, it should not invest so much that it has to resort to frequent financing from outside. In other words, it should not undertake frequent dilution of equity or raise so much debt that its debt to equity ratio spirals out of control.

Looking at prior records helps one understand the company's capabilities. It gives an idea, shows a direction, and helps to understand the company's vision and the path ahead.

Intensive research

The golden rule to investing is considering the future growth prospects of the company you are investing in. During the dot-com boom, many investors displayed a herd mentality, investing in companies without any research. The result was the dot-com bust that followed.

It is important to not only know the company like the back of your hand but also be aware of the external factors influencing the growth of the stock. The overall state of the economy, the factors influencing political and social environment should also be considered while investing.

Sector growth, the demand supply trend and the competition in the sector also need attention before you decide to invest in a particular stock.

Extensive Homework

If you are a serious investor, you cannot go by intuition alone. You will need to do a lot of homework before zeroing on a particular stock. This should not be difficult. We may be considered impulsive buyers, but we do have our own ways of background research before we make the ultimate buying decision.

Homework before investing would include reading up about the company you are about to invest in. Reading its annual reports, studying the balance sheet, analyzing its profits, assets and liabilities; reading interviews of the top management, keeping yourself updated about the latest economic policies.

In short, being the sponge and soaking every piece of news and information related to your investment.

Serious follow up

Keep a constant track of your investments. Regardless of the market condition, whether it is a bear market or a bull market, it is your money that is at the stake. Your hard earned money! You owe it to yourself to ensure that the savings that you have invested are showing a promise and growing.

It's the last mile that makes the difference in the race. It's not just about the right formula but about the grit to see it through. The grit to emerge as a winner.

Don't lose steam once you invest. Serious follow up is what will differentiate you from other investors. It will be your secret weapon, your protective armour, the secret charm that will help you make the best of your investments.

Disclosure NONE

Top 10 Investing Rules of Thumb

Not too long ago, J.D. over at Get Rich Slowly posted 25 Useful Financial Rules of Thumb. These guidelines are designed to help everyday people do more with their finances. We wanted to expand on that idea and make a more investing-specific list, with useful rules of thumb for the everyday, buy-and-hold ETF/index fund investor. Here are 10 investing rules of thumb that can help you make the most of your long-term EFT portfolio:

1. Rule of 72. The Rule of 72 states that you can divide the number 72 by whatever yield you are getting to see how long it would take for your investment to double. Master Your Card has a great example of how the Rule of 72 works in real life:
   

   The membership share he currently has his money in is earning 1% interest. I explain the rule of 72 to him and then write it down on paper so that he can see what I’m doing…I like to draw crazy pictures when I talk numbers. So, I break it down for him. At 1%, it would take 72 years for his $165,000 to double. If he wen back to the money market — our rate up a little — he’d be earning 4.75% on his money and that would only take about 15 years to double. Clearly he’d have more fun in the next 15 years than he would in 72.

   The concept works that same with returns on an ETF. You can estimate how long it will take for the money in your ETF to double if you leave it there at its average yield. Of course, because ETFs can change, it is probably best to figure this number on a five or ten year average (or a longer average if you can find one).

2. “120 Minus Your Age” Rule. The old rule of thumb was to take your age and subtract it from 100. That is your percentage of stock allocation. No Debt Plan, however, points out that with the new life expectancies, that rule is rather conservative. Instead, the suggestion is to change that 100 to 120:
   

   As an individual investor, you need incentive to take risk. That incentive with stocks is — over the long run — higher returns. If you couldn’t earn higher returns in stocks then everyone would invest in safe assets like bonds, CDs, and saving accounts. There would be no incentive to take the additional risk.

   With longer retirements and longer lives, a little more risk at a younger age is needed to make sure that your money will last as long as you do. You can have some or all of your equity allocation in the form of ETFs (or index funds) comprised of stocks. Then, use a bond ETF like BND, or even a TIPS ETF (to protect against inflation),to account for your bond allocation. Note that in our ETFdb sample portfolio we actually recommend using the formula 110 minus your age, but the truth is, any of these rules will achieve the goal of moving to less risky investments as your investment horizon decreases.

3. The Long Term Inflation Average Is 4%.For the immediate future, deflation is one of the major concerns afflicting the economy. However, over time, inflation provides a real hit to your investment portfolio. AllBusiness points this out about assuming an inflation rate of 4%:
   

   An inflation rate of 4% might not seem significant until you consider the long-term effect on your purchases and your investments For example, in 20 years, 4% inflation annually would drive the value of a dollar down to $0.44.

   Inflation also works against your investments. When pursuing long-term financial goals, from college savings for your loved ones to your own retirement, it’s important to consider the real rate of return, which is determined by figuring in the effects of inflation.

   When figuring the real rate of return on your investments, using a 4% annual inflation rate can help you plan more realistically for your future needs. Long-term, buy-and-hold investors know that they need to look at the big picture and add inflation-beating investments to their portfolios. When combined with rule #2, you can set up a long-term investment portfolio that has an asset allocation to that provides a capital preservation base but also offers growth that beats the rate of inflation.

4. Very Few Years Are “Average”. One of the indexes that is routinely touted as a great market beating investment is the S&P 500 (you can “buy” the S&P with an ETF such as SPY or RSP). Indeed, rolling returns from the S&P 500 show an historically high level on an average basis. However, the nature of the stock market is to move up and down; year-to-year consistency is not to be expected. Indeed, columnist Humberto Cruz points out that the S&P rarely makes it’s historical average in any given year:
   

   The average historical long-term return for the S&P 500 Index is about 10 percent a year. But the index rarely comes close to returning 10 percent any particular year.

   In the past 40 years, returns have ranged from a gain of 37.5 percent in 1995 to last year’s 37 percent loss. Only twice — gains of 10 percent in 1993 and 11 percent in 2004 — did gains range between 8 and 14 percent.

   Another thing to keep in mind that inflation must be subtracted from returns as well, so annual S&P gains on a real basis are closer to the 6-7% range.

5. You Need 20x Your Gross Annual Income to Retire. This rule is a great starting point for your retirement planning, though as GRS’s J.D. points out, this 20x your income rule may not be the be-all-and-end-all:
   

   Another approach to retirement savings says that you’ll need to save about 20x your gross annual income to retire. In other words, if you earn $50,000 per year, you’ll need $1,000,000 to retire. Again, I think this is lame because it focuses on income and not expenses, and expenses are what matter. But still, this can be a handy gauge.

   The point, of course, is that expenses may matter more. So use the 20x your income rule as a good starting point, but modify according to your expenses. Figure out how long you think your retirement will be and multiply that by your annual expenses. I think my retirement is likely to last 30 years. 30x my annual expenses of $40,000 (which will go down when I retire and no longer have a mortgage and student loans) is $1.2 million. Will my rule #2 asset allocation help me get there in 20 years when I retire? I can use rule #1 to get an idea. And, of course, I’ll still be adding to my retirement portfolio. Of course, this formula doesn’t take into account me living longer — or needing long-term care.

6. 4% Withdrawal Rule. In order to protect your principal during when you start withdrawing from your investment portfolio, use the 4% rule to figure out how much you can take out. Four Pillars offers an excellent explanation of how the 4% rule works:
   

   The way the 4% rule works is that you start by taking 4% out of your portfolio in the first year - this includes dividends, interest, withdrawals. The next year you take out the same figure you took out the first year plus inflation. So if you start by taking $40,000 out and then inflation is 3% then the second year you take out $40,000 + 3% ($1200) = $41,200. Every year after that you adjust the previous year’s withdrawal amount by the inflation rate.

   Of course, you will probably need to adjust this rule, depending on how your retirement is going, and how well the market is performing. But it’s a reasonable rule that can help you determine how much you can take out. And if your investments are beating inflation (a TIPS ETF can help ensure that some of your portfolio is at least keeping pace), this rule should last you quite some time.

7. Retirement Plan Priorities: 401(k) ’til match, then Roth IRA, then 401(k) ’til max. It’s a good idea to understand your retirement account investing priorities. There is a definite strategy that can be employed when you are putting money into your retirement accounts. The Motley Fool offers some great advice on retirement account priorities:

Your priority should usually be your employer’s 401(k) plan, if it matches your donations to any degree. Take maximum advantage of matching funds, because they represent free money which will grow for you over time. The Roth IRA is the next best option for most people, since it offers a place where your (post-tax) dollars can grow tax-free for many years. Note that you’re probably best off contributing as much to your 401(k) as you need to for the maximum match, then putting your next dollars into a Roth IRA. Once you’ve maxed out the Roth, look at the 401(k) again, and after that, a traditional IRA.

It is also worth noting that another option is the Roth 401(k). I’d consider using that if at all possible, since it combines the higher contribution limit and no AGI restrictions of a 401(k) with the tax advantages of a Roth account. The more you can put into a tax advantaged account, the better. Always wait until the very end to invest in taxable accounts. (Of course, if you’ve reached the point where you are investing in taxable accounts, you’re probably doing rather well!)

8. Save and Invest 10% of Your Pre-Tax Income. Before spending your money, follow the old adage “pay yourself first.” This is great advice! Take 10% of your income (pre-tax if possible) and set it aside, preferably in some sort of account that offers returns, such as a retirement account. Master Your Card offers this observation about the 10% savings rule:
   

   Think about it this way: for every 10 dollars you earn, save at least one dollar for yourself before spending the rest. This practice is often referred to as “Paying yourself first”, implying that you’re paying to build equity in yourself with every paycheck. This money which you’re saving is then kept as a private reserve, which you can invest in a wide array of low-risk investment vehicles. Thus, over time you are building wealth not only through your regular deposits of 10% of your income, but also through the interest being earned on the money you’ve already made.

   One of the best ways to do this is via direct deposit. Have a portion of your paycheck direct deposited into a savings account. Even better, make sure your retirement account deposits are coming out of your paycheck automatically as well. The best policy is to make savings automatic.

9. 10, 5, 3 Rule. This is a handy rule that states that you can expect a nominal return of 10% from equities, 5% return from bonds and 3% return on highly liquid cash and cash-like accounts. Of course, this is a an average return over the long haul. Here is what FIRE Finance points out about what is more likely to be the case this year:
   

   [B]eing conservative in nature and observing the current state of the market we’d rather root for a more achievable 8, 5, 3. That’s our rule of thumb for investing this year. Let’s see how the year unfolds as we go along and the lessons involved.

   And it is worth noting that some feel as though equities offer lower average returns that 10%. The bottom line is that investment returns fluctuate year-to-year. It is also worth noting that ETFs can be used in many of these investments–including stock ETFs and bond ETFs. There are even cash and currency ETFs, such as FXE.

10. Required Return. There is an interesting formula to help you figure out your required return (this is a bit more advanced than our other rules, but it’s a useful one). It looks as follows: Required return = risk free rate + beta (historical market return - risk free rate). Allan Baraza offers this explanation of what each of the parts to this equation represent:
    

    The risk free rate is the return on a 5 or 10 year government note. Choice of notes to use will depend on time horizon used to estimate the historical market return.
    Beta is a measure of a stock’s volatility; the higher the beta, the higher the volatility. This volatility is relative to the market volatility. A stock with a beta of 1.5 means that the stock will rise 15% with a 10% rise in the market; conversely, it falls 15% with a market fall of 10%. It follows, then, that the market beta is 1.
    Historical market return is a regression estimation of the return over the estimation time period.

    He points out that during times of uncertainty and volatility, lower beta stocks are preferred. You can learn a little more about the advantages and disadvantages of beta in a useful Investopedia article on the subject.

These ten investing rules of thumb should serve you well in building and maintaining your ETF portfolio. Of course, there’s more to personal finance than just investing, so if you’re not yet to the point where you find this article to be helpful, you’ll want to check out GetRichSlowly’s 25 Useful Financial Rules of Thumb first.

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The ETF Investing Toolbox: Top ETF Blogs, Newsletters and Tools by Miranda Marquit

One of the hottest investment trends is ETF investing. Exchange traded funds can be traded on the stock market like stocks, but they track index funds. ETFs bundle securities on an index, eschewing mutual funds. It is relatively easy to trade ETFs, and there are ETFs that track bond indexes, commodities and currencies. Because they track indexes, they are normally relatively low cost to trade since there are no load fees involved. ETFs can be incorporated into long-term investment portfolios, as well as used by day traders. If you are looking to learn more about ETF's, here are 50 blogs, newsletters and tools that can help you on your way.

ETF Information and Overview

Here are a number of ETF blogs and other article sources that offer insight into the world of ETFs. These include a number of useful articles aimed at beginners, as well as insights for more advanced traders.

1. Seeking Alpha "ETF Sector" provides a number of articles about exchange traded funds, ETF picks and news regarding the latest developments.

2. MorningStar's Exchange-Traded Funds section provides a number of tools for ETFs, including definitions, rankings, screenings and cost analyzers to help you figure out what will work best for you.

3. MarketWatch "ETF Investing" is written by John Spence, one of the MarketWatch columnists. It offers information about what is going on right now in the world of ETFs, providing information that can be used to help you make investing decisions right now.

4. About.com "Exchange Traded Funds" provides a number of helpful articles and news stories on ETFs, as well as links to resources related to exchange traded funds

5. The Motlety Fool "ETFs " has a number of informative articles on ETFs, as well as a handy "60-second guide."

ETF Blogs and Blog Posts

There are a number of blogs devoted to ETFs. And many investing blogs devote at least an article or two to ETFs. Here are some blogs and blog posts that can provide you with some commentary, news and analysis related to ETFs.

1. ETF Expert is a blog that offers daily commentary on ETFs, as well as a link to a radio show devoted to ETF investing.

2. The ETF Corner is a blog that specializes in technical analysis and ETF trading.

3. Rocket Science Investing is a blog that focuses mainly on ETFs, and includes investing news and ETF-specific news.

4. ETF Digest offers market comment in blog form, plus access to podcasts, and information on ETF hedge fund portfolios.

5. ETF Database has a library with articles particularly aimed at beginning ETF investors.

6. ETF Trends provides analysis, news and more regarding exchange traded funds.

7. My Wealth considers ETFs for the average investor.

ETF Newsletters

There are a number of newsletters put out periodically that cover ETF news, strategies and resources. You can usually have these newsletters directly delivered to your inbox in order to get fund news fresh every day. Many of these cost money, however, so consider carefully which you choose to subscribe to.

1. Forbes offers an ETF newsletter packed with the sort of information you would expect from one of the online leaders in investing information and analysis.

2. The ETF Review from Investors Intelligence is a weekly newsletter that offers fund picks, charts, trends and commentary.

3. ETF Investment Outlook is a newsletter that looks at advances and declines in ETFs, and provides insightful articles and information. Technical Talk and ETF Basics are highlights of this online newsletter.

4. ETF Investor Newsletter offers a look at news and information, as well as helpful ETF listings and personalized information aimed at your portfolio.

5. ETF Global Investor claims to help you find the best ETFs for your money.

6. ETF Expert provides a weekly newsletter that you can have delivered right to your inbox.

7. ETF Trading Signals is a newsletter focused on providing tips and signals on ETF news.

ETF Tools

There are many tools that you can use to improve your ETF investing strategy, or find ETFs that might fit into your portfolio.

1. Total Return Calculator from NYSE Amex allows you to enter purchase and sale information (including commission) to figure out total return on an ETF investment.

2. ETF Screener from NYSE Amex helps you screen prospective ETF investments, allowing you to choose a variety of parameters to help you choose the best ETF for you.

3. ETF Center from Schaeffers Reserch provides current quotes on ETF prices, most active ETFs and indicators for ETF trading.

4. ETF Desk helps you find ETFs, and develop strategies for them. It is an interactive online ETF community.

5. ETF Screen is a screener that lets you choose from a variety of views, as well as different sectors. There is also a performance comparison.

Miranda Marquit writes for Bankling, a new portal for personal finance information, which publishes a blog, and a resources section that contains tools like the best bank CD rates, the best savings account rates , online mortgage rate calculators and more.

This blog comes from the Etf Expert click here to view his site.