Dividend stocks in this time of tax policy uncertainty

woman holding check

With interest rates remaining at near-zero levels, the hunt for yield remains fierce. Hence the ongoing popularity of stocks with fat dividend yields. Now, as President Obama heads into his second term, there’s much talk in Washington about the expiration of the Bush-era tax cuts and other policy changes that could make dividend paying stocks far less attractive.

Much depends on what sort of debt and tax reform deal Congress and the White House come up with. As things stand now, if taxes rise as planned at the end of 2012, folks in the top marginal income tax bracket could see the tax on their dividend payments more than double – from the current 15% to 39.6%. All things being equal, dividend paying stocks would become far less attractive and offer less alluring returns.

But not so, says James Morrow, the portfolio manager of Fidelity Equity-Income Fund.  Morrow recently published a report making the case for dividend paying stocks even if the tax policy climate turns less hospitable.

For starters, Morrow and his team delved into the historical data and could find no meaningful correlation between changes in dividend tax rates and the performance of dividend paying stocks. That was even true back in 2003 when the dividend tax rate fell by more than half to 15%: Look what happened to high yielding stocks then, when you’d expect them to become more attractive:

bush tax cuts

Morrow therefore also sees demand for dividend paying stocks holding up just fine even if taxes eat into return. For one thing, as he points out, 34.4% of investors’ equity assets sit in tax-advantaged accounts such as IRAs and 401(k)s.  “A dividend rate increase has no impact on those accounts,” Morrow notes  “If dividend rates do rise, investors might want to sell the dividend stocks they hold in taxable accounts, but they could easily replace them by buying shares in tax-advantaged accounts.”

In any case, Morrow recommends keeping some dividend paying stocks in one’s portfolios. Companies offering high dividend yields tend to be cash-rich and well run. “These positive attributes need to be in place before a company even pays a dividend, so the stocks of dividend payers tend to be less risky than other stocks,” he argues.

Want to see which stocks and ETFs boast high dividend yields? The Wall Street Journal has a good stock scan for this.

And take a look at these yield focused portfolios offered by our current lineup of Covestor managers:

Certain information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The author believes that such statements, information and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.