Dividend Aristocrats Are Overrated: Here’s Where Income Investors Might Want to Look Instead

It’s hard not to like an impressive track record. And make no mistake about it — any stock that lands a spot among the Dividend Aristocrats has a great track record.

To earn the designation of Dividend Aristocrat, a company must first build a market cap big enough to be included in the S&P 500 index. Then, the company must increase its dividend for 25 consecutive years.

While those achievements are undoubtedly impressive, I think there’s a good case to be made that Dividend Aristocrats are overrated. Here’s where income investors might want to look instead.

Image source: Getty Images.

Overrated? Yep

Before I’m accused of dividend blasphemy, allow me to explain my position. I’m not maintaining that every Dividend Aristocrat is overrated. I even wrote recently about three Dividend Aristocrats that are worth buying right now (including two that I personally own).

But I do think that many Dividend Aristocrats are overrated. My view is that enough are overrated to claim that the group as a whole often receives too much attention from income investors.

As my first piece of evidence, just look at the total returns of Dividend Aristocrats over the long term. You don’t have to pull up every Dividend Aristocrat on a stock chart to do this, by the way. The ProShares S&P 500 Dividend Aristocrats ETF (NYSEMKT: NOBL) serves as a great proxy. This exchange-traded fund includes all Dividend Aristocrat stocks.

NOBL data by YCharts.

The S&P 500 index as a whole has soundly beaten the Dividend Aristocrats ETF in total return since the ETF launched in late 2013. Some might argue, though, that this isn’t surprising. After all, the primary attraction with Dividend Aristocrats is the income they offer and not their growth.

But the dividend yields of Dividend Aristocrats won’t excite many investors. The ProShares S&P 500 Dividend Aristocrats’ dividend yield currently stands at 1.94%. You’d have to invest a massive amount of money for that yield to provide a significant amount of income.

My final critique of Dividend Aristocrats is that some of them only increase their dividends slightly each year — just enough to stay in the club. For example, Dover‘s (NYSE: DOV) dividend has risen by a grand total of 4.17% over the past three years.

An alternative worth considering

I think that income investors should at least consider the alternative of buying closed-end funds (CEFs). They’re a type of mutual fund that doesn’t issue new shares. Unlike mutual funds, though, you can buy or sell a CEF on a stock exchange in the same way you can trade an ETF.

Many CEFs are laser-focused on meeting the needs of income investors. Some of the funds focus on bonds. Others focus on preferred stocks, which tend to offer higher dividend yields than common stocks do.

For example, the AllianceBernstein Global High Income Fund (NYSE: AWF) specializes in corporate bonds. Its yield of 7.2% blows away most Dividend Aristocrats. The Nuveen Preferred Securities Income Fund (NYSE: JPS) invests primarily in preferred stocks and income-producing securities. Its distribution yield stands at 7.3%.

Investors can often find CEFs that trade below their net asset values (NAVs), the total value of the funds’ assets less its liabilities. Both the AWF and JPS funds are currently priced below their NAVs.

Pros and cons

There are several pros associated with CEFs. Many of them generate significantly higher levels of income than Dividend Aristocrats do. These funds can be easily bought and sold on online brokerages.

Investors can also gain access to certain bonds and preferred stocks that they’d normally have to go through a financial advisor to purchase. This is an important thing to consider because the best CEFs are run by managers who are especially adept at identifying the most promising income-producing assets.

However, there are some cons with CEFs as well. They charge fees. You’ll want to research the performance of individual CEFs to make sure you get your money’s worth. Some CEFs use leverage (including those mentioned earlier) to boost income and returns. This can increase their volatility.

Also, most CEFs won’t deliver the total returns that stocks will, including many Dividend Aristocrats. This is a direct result of the CEFs’ focus on income.

If CEFs received the same level of attention as Dividend Aristocrats, I might even argue that they’re overrated, too, in light of some of their drawbacks. That’s not the case, though. Many investors hear a lot about Dividend Aristocrats but practically nothing about CEFs. My view is that the impressive income track records for CEFs make them worth a look.

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Keith Speights has no position in any of the stocks mentioned. The Motley Fool owns and recommends ProShares S&P 500 Aristocrats ETF. The Motley Fool has a disclosure policy.

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