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Which stocks are good sources of income?

February 03, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Q: What are some good stocks for income production?

A: With rates on CDs, savings accounts, and money market accounts near zero, it is only natural that people should be looking for alternative sources of income. One possibility for this is investing in stocks with a decent dividend yield. However, before taking that step you need to fully come to grips with the substantial risk differential between stocks and savings accounts.

Savings accounts do not fluctuate in value, and they are guaranteed by FDIC insurance for amounts up to $250,000 per depositor. Stocks, on the other hand, fluctuate in value constantly, and some losses can be steep and permanent. So investing in stocks as an income alternative to savings accounts is fine as long as you aren't expecting a comparable amount of stability from the investment. Also, keep in mind that even if you can live with price fluctuations, stock dividends are not guaranteed. In times of financial distress a company may reduce or completely eliminate its dividend.

One way you can reduce risk is through diversification. That means spreading your money across a number of different stocks. This can make the portfolio less volatile than any one stock might be, and it also cushions you against the risk of any one company cutting its dividend. So, to take a diversified approach, you should be thinking about which sectors as a group tend to produce good dividend yields, rather than thinking in terms of individual stocks.

The S&P 500, which is a broad cross-section of large U.S. stocks, has an overall dividend yield of about 2.22 percent. However, some sectors of the S&P 500 produce much more dividend income than others. For example, the dividend yield on telecommunications stocks is 5.32 percent. Other relatively high-yielding sectors include utilities, at 4.02 percent, and consumer stables, at 3.0 percent. In contrast, information technology is the lowest yielding sector, at 1.20 percent.

Naturally, then, one approach you could take is to focus on the higher-yielding sectors of the stock market. As an alternative, Standard & Poors publishes a list of what it calls "Dividend Aristocrats." These are companies within the S&P 500 that have increased their dividends every year for at least 25 years. This list of Dividend Aristocrats would be a good place for you to look for income-producing stocks. There are 51 stocks on the list, which is a broad enough selection to enable you to assemble a reasonably well-diversified portfolio, if you choose to take this approach.

Historically, dividend yields have not generally been competitive with interest rates, so the current situation is something of an anomaly. However, as long as that anomaly persists, it is worth considering stocks for their income production.

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