One of the few constants in investing is dividends. Stocks that consistently pay quarterly dividends can be a safe harbor in virtually any type of market, including the volatile, diminished one that we're in now.

Investors in companies that consistently pay dividends can generally count on steady returns, and their shares tend to have low price volatility. Also, as they mature and thus need less capital to grow, companies that pay quarterly dividends tend to increase the amounts of these payouts.

Dividend yields have increased dramatically as stock prices have declined in recent months. This comes on the heels of a trend, triggered by legislation in 2003 that gave dividends tax parity with capital gains, in which many companies began increasing dividends to make shares more attractive. Over the next few years, as companies look for a way out of the current share-price trough, some will doubtless seek to enhance their appeal by increasing dividend payouts.

Dominant Role

Clients who are understandably nervous about the current bear market may be interested to know the dominant role that dividends have historically played in performance. Many of these clients are aware that before the current bear, total returns had historically averaged 10%. Considerably fewer may know that about 42% of this return came from the dividend component.

Despite dividend stocks' historical reliability, many analysts have long regarded them as inferior to their polar opposite, growth stocks. Conventional wisdom has conditioned investors to acquire growth stocks under the belief that they'll provide the highest long-term returns.

Yet, as disappointed investors revolt against growth strategies that have failed them over the past decade, there's an emerging awareness that they might be better off basing portfolios instead on foundations of dividend stocks.

Over the 10-year period through 2008, the Dow Jones Industrial Average declined in price 14.5%. Yet as of March, the Dow had an average dividend yield of 4.6%. This has lessened the damage from the second-worst bear market in history. Though this recent bear market has thus far been caused by different fundamentals than those of the preceding decade, there's no clear reason to doubt that dividend stocks' tendency to buttress market returns is going to change.

Out of the 7,000 U.S. companies reporting dividend actions to the S&P, 475 indicated that they increased dividends in the fourth quarter of 2008 versus 288 that cut dividends. However, in the current market, in which some companies have cut dividends and still other financial stocks are now required to cut their dividends as condition of their acceptance of the government bailout money, investors interested in dividends need to do their homework. They must make sure that the stocks they buy or own have enough cash flow from operations to continue to support dividend payouts.

Companies experiencing rapid growth don't tend to pay dividends because they reinvest their cash. In seeking the highest returns from these stocks, many investors create diversified yet passive (buy-and-hold) portfolio allocations to reap the benefits of rising stock prices over time. This strategy can work—in theory. In reality, it has failed many investors because, during periods of market turbulence like the present, many individual investors tend to abandon their buy-and-hold disciplines and sell low, destroying their capital bases. As a result, high returns from growth stock portfolios have become even more elusive in recent years.

One widely used strategy holds that retired investors will be better off buying growth stocks than dividend stocks—because of what they assume will be a higher return—and then systematically selling appreciating shares at ever-higher prices to produce retirement income. This approach can also lead to significant capital depletion as share prices fall in negative market cycles. This high-risk strategy geared to produce retirement income may prompt retirees under pressure to pay living expense to sell low amid high volatility.

Such systematic withdrawal-plans-gone-awry result in what I call "dollar-lost averaging." Even in its mildest form, dollar-lost averaging increases the risk that retired investors will outlive their assets.

By shifting their portfolio focus from growth stocks to dividend payers, these investors can significantly lessen this risk. As these stocks provide revenue in the form of dividend payouts, there's less pressure to sell.

Dividend Advantages

Advisors can create balanced portfolios using a mix of bonds and high-yielding dividend stocks to lower risk and fight inflation. While discussing dividend stocks with your clients, you might mention these advantages:

• Providing independent income streams. Investors can generally count on dividend income regardless of movements in the price of the underlying stock.
• Allowing investments to grow at compounded rates. At the end of each quarter, dividends received can be used to fund the purchase of more shares and so forth each quarter.
• Enabling dollar-cost averaging. By systematically reinvesting dividends, investors can compensate for price fluctuations and lower the average purchase price of shares over time.