Downside to dividends?

For the past few years, dividend investing has been all the rage.  With the US Fed targeting low interest rates in a strategy to stimulate the economy, traditional income investors have been squeezed out of bonds and pushed towards other sources of cash flow.  As a proxy for the move in the larger bond market towards lower yields, consider this 5 year look at the 10 year treasury note:

10 Year Treasury Rate data by YCharts

For those investors on a "fixed income", such as a retirees depending on the wealth they accumulated during their working years to sustain them throughout the remainder of their lives, a drop in yield from around 4% down to 1.5% - 2% represented a significant challenge.  Is it any wonder that many of those investors began to explore other avenues for income?  For many of these people, dividend paying stocks appeared a good option.  Well known companies like General Electric and Johnson & Johnson were paying dividend yields at levels much higher than the US treasuries, and competitive with corporate bonds.  Here is a chart of the JNJ dividend yield over the last 5 years to contrast with that of the Treasury chart above:

JNJ Dividend Yield data by YCharts

From this view, the argument for dividend stocks versus bonds seems compelling.  And it may very well be that a diversified portfolio of dividend stocks with strong underlying economics could meet an investor's objectives for income and growth while meeting their tolerance for risk; however, there are downsides to dividend paying stocks.  Here are a few to consider when weighing investment options:

• Stocks are volatile.  While bonds have a defined term and are designed to mature at "par" at the end of that term, stocks are open ended investments and their price will bounce around considerably with any number of market influences.  This price movement can easily erode any value derived from the dividends, especially if the investor has to sell for liquidity during a "dip" in price.
• Dividends are discretionary.  Again, consider the contrast to bonds: the coupon and maturity on a bond are contractual; if the company fails to honor the terms of the bond, they are in default and the bond owners have legal recourse.  Dividends are at the discretion of the company's board; a company can suspend dividends at any time and for a variety of reasons.
• Dividends are volatile.  As mentioned above, a company can stop paying a dividend at time, and may also raise or lower dividends for a number of reasons.  During the fallout of the 2008 "great recession", General Electric cut their dividend substantially.  Below is a 10 year chart of the GE payout in $ per share:

GE Dividend data by YCharts

Income investors holding GE stock through that period would have seen their cash flows drop significantly, from more than $0.60 per share down to $0.20, while also seeing their share price drop from a high in the $40s all the way down to a low below $7.50!  

To summarize, dividend paying stocks may be a reasonable fit for investors seeking income, but those stocks come with considerable risks and volatility that must be considered within the broader context of the investor's risk tolerance and investment objectives.