Dividend Dilemma: Is It Worth it to Get in the Game?

Investors who want steady income are having a hard time of it these days, as yields on bank savings, money markets and government bonds are pitifully low. You’re lucky to get 2%, and would have to tie your money up a pretty long time to do any better.

So why not look to dividend-paying stocks?

Consider the top three dividend payers in the Dow Jones Industrial Average. AT&T (Stock Quote: T) pays 6.41%, Verizon Communications (Stock Quote: VZ) pays 6.25% and Dupont (Stock Quote: DD) 4.4%. (These are all estimates for the 12 months beginning Sept. 17, by investment-data firm IndexArb.)

Dividends are corporate earnings paid out to shareholders. Dividend yield is total dividends paid over 12 months divided by a stock’s current price. A $100 stock paying $6 in dividends over a year yields 6%. This means that dividend yield is comparable to interest rate. So the 4.72% paid by Merck (Stock Quote: MRK) is a lot better than the 1.52%, which is what you’d earn on the average two-year CD, according to the BankingMyWay.com survey.

Also, the federal tax on dividends is 15%, while interest earnings are taxed as income at rates as high as 35%.

It all sounds great, and lots of investors, including many retirees, swear by dividends. But there are things to watch out for.

The most obvious is the risk that a stock which pays a generous dividend could fall in price, creating a loss despite the dividend earnings. The search for generous dividends should therefore include all the analysis you’d do before any stock purchase.