That's because some of the tax increases associated with the fiscal cliff could deliver a hefty tax hike to dividend income.
But the possibility of higher dividend taxes doesn't mean you should ignore the sector altogether.
History shows that dividend-paying stocks have outperformed non-dividend shares even at a time when taxes were much higher. For income-seeking investors, any pullback in dividend-paying stocks as the fiscal cliff approaches may just be a buying opportunity.
Investors early to the game will enjoy dividend payments and also benefit from these companies' healthy market performance.
Fiscal Cliff Effect on DividendsIf nothing is resolved before year-end and Congress fails to take action, dividends received will be taxed as ordinary income instead of the current maximum 15%. Ordinary income tax rates are scheduled to revert to pre-2003 levels, with a maximum of 39.6%.
In addition, a new 3.8% tax will be tacked on to help pay for the Affordable Care Act. For some taxpayers, dividend taxes would nearly triple.
But remember, before investors enjoyed the 2003 dividend tax breaks that put dividend taxes on par with capital gains taxes, payouts had been taxed for decades at ordinary income rates. For some, the tax was as much as 91% in the late 1950s and early 1960s, 70% in the 1970s and 50% in the early 1980s.
Despite those lofty tax rates, dividend stocks continued to maintain a prominent position in portfolios of income oriented investors, and these stocks continue to share their wealth with satisfied shareholders.
From the end of 1979 through July 2012, dividend-paying stocks in the Standard & Poor's 500 Index carried an annualized total return of 12.1%. That compares with a 10.7% return for nonpayers, according to data from research firm S&P Capital IQ.
MarketWatch did the math and calculated that an initial investment of $10,000 in the dividend bunch would have morphed to a whopping $408,000 over that time frame compared to $271,000 for the nonpaying group.
Dividend Stocks Will Continue to MatterSo despite the threat of fiscal cliff 2013, an increase in dividend taxation is not a reason to run from dividend stocks.
Besides, where do you run to?
Treasuries, CDs, money markets and savings accounts yield next to nothing. With interest rates destined to stay low for a least the next couple years, there is little to no hope of better returns from these savings instruments.
Plus, the possible tax increase on dividends will have a minor impact on a stock's overall performance. What does matter is the overall health of a company - something a strong dividend represents.
Money Morning's Global Investing Strategist Martin Hutchinson recently pegged a list of his own "dividend aristocrats." These are companies which have not only maintained, but increased their dividends for more than half a century.
Hutchinson noted that the best part of the fabulous four he found is "you even get the diversification of four different sectors along with ultimate dividend producing, sleep-at-night investments."
- The Procter and Gamble Co. (NYSE: PG) has increased its dividend every year since 1954. The household goods conglomerate has a dividend yield of 3.7%
- Northwest Natural Gas Co. (NYSE: NWN) has increased dividends every year since 1956. Operating as a storage center and distributor of natural gas in Oregon, Washington and California, it sports a 3.7% dividend yield.
- Emerson Electric Co. (NYSE: EMR) has raised dividends yearly since 1957. A worldwide engineering services company, EMR boats a dividend yield of 3.5%
- Cincinnati Financial Corp. (Nasdaq: CINF) is a property and casualty insurance company that carries a dividend yield of 4.2%. EMR has boosted its dividend every year since 1961.
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