A prudent way to save up for the future has many investors putting their wealth into dividend-paying stocks and related exchange traded funds (ETFs). But an investor may wonder if he or she should be investing in dividend yield or dividend growth.

Stocks operating with high dividend yields could have recently experienced a drop in share prices or be an “out of favor” money maker, remarks ETF Guy for ETF Topics. A company could have also raised its dividend in the past and can be considered a dividend growth stock.

In a hypothetical situation, a dividend yield investor sees a 13.0% yield for a stock and a dividend growth investor sees a stock with 2.0% yield and an average annual dividend growth rate of 10.0%. It is calculated that the dividend yield stock will start paying out 5.0% in 10 years. But a dividend yielding stock does allow an investor to receive some extra money on a regular basis.

Investors utilizing dividend yield stocks have an opportunity to use higher dividend profits to either retire or grow an investment portfolio. Dividend growth stocks may not provide enough for retirees.

When investing into dividend stocks or ETFs, it is important to have your own strategy in place for the time frame you have in mind. ETF Guy thinks the obvious solution is to have a balanced investment in both dividend yield and dividend growth type stocks, but every investor is different. Consider your own goals and needs.

• SPDRS (SPY): yields 2.7%; up 0.8% year-to-date

• PowerShares International Dividend Achievers (PID): yields 3.4%; up 8.6% year-to-date

• PowerShares Dividend Achievers (PFM): yield 2.9%; down 9.0% year-to-date

• iShares Dow Jones Select Dividend Index (DVY): yield 5.5%; down 13.5% year-to-date

Created by Tom Lydon

Max Chen contributed to this article.

Frequent readers of dividend blogs will know that most sophisticated dividend stock investors compare dividend yields to bond yields (or high yield money market funds) as one quantitative measure of assessing risk and valuation (see Dividends4life’s analysis of (JNJ) Johnson and Johnson as an example). But what are we to make of the strange behavior between dividend yields and bond yields in the last six months?

The conventional pre-1950’s thinking was that, given that equities are, by nature, a riskier investment class than fixed income, equity needed to pay out greater than fixed income returns to over-come the structural risk. After all, why would you invest in something without some cash being returned to you over the life-time of your investment (oh, how times have changed!)? Since anyone could purchase U.S. treasury note with guaranteed payment, dividend yields needed to be greater than treasury yields to entice investors to invest in equities.

How great? One researcher found S&P 500 dividend yields from the period of 1871-1967 were approximately 20% greater than AAA corporate bond yields.

However, from 1958 until December 2008, dividend yields of the S&P 500 have paid less than the interest on a 10 year treasury note by an average margin of 3.6% in favor of bonds. In December 2008, the pre-1958 pattern of dividend yields being greater than bond yields reverted due primarily to plunging stock prices.

But with the recent rise of the stock market, dividend yields on the S&P 500 are now equal to or lower than yields on a 10 year treasury note, meaning a return to the 1958-2008 era. Assuming this pattern continues to hold true, and the period of December 2008 to circa May 2008 a blip in the continuing trend towards bond yields paying more than dividend yields, what do we make of all of this?

On a relative basis, one could argue that our general perception of risk, even 18 months into a economic downturn, may not have undergone a large shift. Unless one assumes that total return of a stock (dividend plus stock price increase) will be greater than a guaranteed fixed income instrument in a % than negates the relative risk of investing in equities,  common sense thinking would dictate that an investor, in a volatile market, demand a dividend yield which would be greater than guaranteed fixed income yield as downside protection of this investing environment.

Call this the “bird in the hand” school of investing.

While risk perception individually may be acute, the market, as a whole, by driving down dividend yields below fixed income yields appears to be ignoring the bird in the hand school of investing and thinking that a 1958-2008 era of focusing on total returns is about to return.  It remains to be seem whether this analysis is true but it is premised on the assumption that we should rely on stock price appreciation more than dividend payment as basis of equity valuation. The existence of this school of thought, despite recent market shocks, may be due to the fact that many of  the players who drove the market to bubbles continue to remain in charge, such being the complicated nature of the system created today that the only people who can  steer the economy to a safe landing are the people who crashed the plane in the first place.

On an absolute basis, what are we to make of the fact that dividend yields are heading  below 3%? If you are an old-school investor, a dividend yield of the S & P 500 of 3% or below is conventionally thought of as a warning sign to move from equity to other asset classes; by the middle of this decade, when the first of the bubble warnings begun, dividend yield was hovering around 1.5%-2%.  In other words, plunging dividend yields can be used as an indicator that stocks are over-valued and a correction is forthcoming. Dividend yields of the S & P 500 fell to 3.12% as recently as May 7.

If you are in the glass half empty camp, you read the S &P 500 dividend yield moving down towards 3% as a sign this is a false market recovery: too much money sloshing around with too many active managers with itchy fingers. If you are in the glass half full camp, you believe that this is a return to the go-go days of 1958-2008 and that dividend yields are not as important as a total return analysis. If you a believer that hyper-inflation is coming, then dividend yield will be the only thing that matters going forward since we are approaching not the 1930’s but the 1970’s where the stock market went side-ways for a decade and most of one’s return on equities was based on dividends and not price appreciation.

Is this as clear as mud? Of course it is. It only means that the only certainty is uncertainty (and beware anyone who says they can predict anything with certainty- they suffer from the emperor has no clothes syndrome) and, if you used dividend vs. bond yield as an indicator of asset allocation (which is one of many tests), the recent market uptick of the last 9 weeks is far too small of a sample size to form a basis of large-scale decision making. 

By: Thicken my Wallet 

Don’t limit yourself to U.S. blue chips.

American blue chips have been the backbone of many investors’ portfolios for the past century. In fact, Coca-Cola (NYSE: KO), Merck (NYSE: MRK), and Tootsie Roll (NYSE: TR) were three of the best S&P 500 stocks from 1957 to 2003, according to research by Wharton professor Jeremy Siegel. For some, these stocks helped build sizable fortunes.

Though some domestic blue chips have slashed their dividends in recent months, those with strong balance sheets and plenty of free cash flow to support their payouts will continue to play an important role in our portfolios into the 21st century.

But restricting yourself to just American blue chips now would be like entering a prizefight with one hand tied behind your back. To capitalize on the benefits of this century’s best dividend-paying stocks, you need to look outside our borders.

Stamp your passport
Over the past decade — especially the past six years or so — it has become clear that the global economy has become more closely integrated than at any other point in history. Today, capital can find its way to just about any country with relative ease, allowing investors to search the globe for the best available returns.

What’s more, you’re likely to find more companies paying higher dividends abroad. The average dividend yield of the U.K.’s FTSE 100, for example, is near 4.0% — a good bit higher than the S&P 500’s 2.1%. Moreover, the NZX 50 index in New Zealand pays nearly three times the S&P, with an average dividend yield of about 6.0%.

It isn’t even close
Foreign cash cows have been beating up their American counterparts since 2003, even including recent market volatility. A screen on Capital IQ for companies capitalized at greater than $1 billion, with a current dividend yield exceeding 2%, illustrates the profound disparity quite nicely.

Despite the global market downturn, which in many countries has been far worse than here in the U.S., about 40% (57 of 143) of foreign dividend-paying stocks that trade on a U.S. exchange have more than doubled in the past six years. Included in this group areCNOOC (NYSE: CEO) and Rio Tinto (NYSE: RTP).

On the other hand, only 22% (80 of 362) of U.S. companies that meet these criteria have more than doubled since May 2003. Some of the select stocks on this list include McDonald’s (NYSE: MCD) andChevron (NYSE: CVX).

Achtung, baby
There are always added risks to consider (politics, currency, etc.) before investing abroad, but dividend-minded investors stateside will want to note two things in particular.

1. Dividend regularity. Or lack thereof. Foreign-company dividends may be larger, but they’re often less regular in timing and amount. Companies abroad like to pay out a target percentage of earnings instead of a certain dollar value every year. Don’t knock it: Freed from the pressure to lowball their payouts, these companies can pay you more over the long haul.

2.Dividend taxation. Foreign countries (the U.K. is an exception) will scalp your scratch by their going rate. Still, most countries in which you’re likely to invest have tax treaties with the United States (Google “IRS publication 901″ for the complete list), meaning you can claim a credit for the tax withheld. Here’s the rub: Because a credit offsets taxes you would have otherwise paid, it’s smart to hold foreign stocks in a taxable account. In other words, skip the IRA if you’re going abroad.

By Todd Wenning, The Motley Fool via MSNBC

With stocks rallying for over 2 months now, dividend yields continue to fall back to Earth.  The average dividend yield of the Dow 30 has fallen nearly 30% since the rally began in early March.  Combined with dividend cuts made earlier this year from companies like CNBC parent, General Electric $GE and Alcoa $AA, the average yield is now 3.1%, far from the 4.5% we saw in early March. 

Below is a table listing the yields of all 30 Dow components.  Since April, AT&T $T continues to be the highest yielding stock on the Dow.  Merck $MRK  and Verizon $VZ have moved ahead of DuPont  $DD  for second and third place.