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The Safer Alternative to High-Risk Dividend Stocks

Dan Caplinger
January 25, 2013

The ideal situation for anyone living off their investments is for your portfolio to generate enough income so that you never have to touch your principal. With interest rates having fallen to rock-bottom levels in recent years, however, finding sound, secure investments that pay you enough income to get by has become an increasingly difficult challenge to overcome.

Fortunately, there's a strategy that will let you get the money you need from your portfolio without choosing stocks that are riskier than you're comfortable owning. It's not the perfect solution for everyone, but it provides a different view of your portfolio that focuses less on pure income and more on choosing the best overall investments you can find.

Why dividend stocks have become so popular
The reason that so many investors have gravitated to dividend stocks is simple: Most of the good alternatives have disappeared. Rates on 10-year Treasury bonds remain stubbornly under 2%, and most corporate bonds pay only small premiums to Treasury rates. Bank CDs generally yield between 1% and 2%, even if you're willing to lock up your money for several years. In order to get solid yields, you have to be willing to take on the increased default risk of speculative-grade high-yield bonds -- a sacrifice in quality that many investors are reluctant to make.

In an effort to make up for shortfalls from bonds and other traditional income investments, many retirement investors have increased their portfolio risk level by loading up on dividend stocks. But in many cases, finding stocks with dividend yields that are high enough to meet your income needs involves buying into companies whose futures are uncertain.

For instance, take the mortgage REIT industry. The double-digit yields that many mortgage REITs offer are unquestionably among the highest the market has to offer. Yet in the current environment, they come with a lot of uncertainty. Industry leader Annaly Capital (NYSE: NLY) has seen its dividend decline in recent years, and with its proposed buyout of Crexus (NYSE: CXS), many believe that Annaly's core business model may be under threat from the Federal Reserve's actions to buy up mortgage-backed securities. Meanwhile, Chimera Investment (NYSE: CIM) is a less-