Dogs of the Dow can sniff out income

Collecting most things — except, say, cobras — is a fun, easy way to spend your time. But one of the hardest things to collect these days is income from your investments.

The average money market fund yields 0.02%, which means a $1,000 investment will give you two shiny new dimes in interest over the course of a year. You could collect two bottles from the roadside and get the same return.

Over the next few weeks, we'll talk about how to get more income from your portfolio, starting with stock dividends. And, while you can only turn in bottles for cash in nine states and Guam, you can collect income from your investments most anywhere. One place to start is with the Dogs of the Dow.

Savings rates — what you can collect from risk-free investments, such as Treasury bills and insured bank deposits — are largely determined by the Federal Reserve's key fed funds rate. Unfortunately, the fed funds rate has been stuck at near zero since December 2008.

This is not the normal state of things. The three-month T-bill yield has averaged 3.64% since 1934, according to the Treasury. (For true bond nerds, this is the discount rate, which somewhat understates the actual yield.) Eventually — possibly as soon as this spring — the Fed will start raising short-term rates. But it's unlikely the U.S. will return to the long-term average anytime soon.

In the meantime, investors have to either make do with very little investment income, or look elsewhere. And looking in places other than from risk-free investments means you're taking risk.

For long-term investors who are comfortable with owning stocks, dividends are one of the best places for income. Dividends are cash payouts to investors. Although sometimes companies reward investors with special, one-time dividends, most companies pay dividends four times a year.

Currently, companies in the S&P 500 pay an average 2% dividend. While that may not sound like much, dividends make a tremendous difference over time. The past 10 years, the S&P 500 has gained 70%. Throw in reinvested dividends, and the index is up 109%.

The main advantage to dividends: Companies often increase them. Consider Clorox: The company paid 84 cents a share in dividends in 2000, according to the company. It paid $2.96 a share last year. Its current dividend yield — past 12 months' payout divided by current price — is 2.96%.

Companies that raise their dividends tend to do so prudently, because there are few things that Wall Street hates more than a dividend cut. A company that raises its dividend tends to be confident that it can afford to keep its dividend at that level.

By that measure, companies have been pretty confident lately. The Standard and Poor's 500-stock index dividend payout rose 12.7% in 2014, setting a record.

While we normally think of dividends as the domain of boring companies like, well, Clorox, tech companies now account for 14.93% of the S&P 500's total dividend payout, the largest dividend payout of any sector. In 2005, technology was just 5.45% of the S&P 500's payout.

Unfortunately, dividends come with all sorts of risks. The first, of course, is that dividends come from stocks, and stocks carry considerable market risk. If you equate stocks with, say, cobras, then you're not going to be happy moving money to dividend-paying stocks.

As we mentioned earlier, Wall Street treats companies that reduce or eliminate dividends like pit vipers on crystal meth. For that reason, you should be wary of investing in stocks with unusually high dividend yields. Stocks don't have high dividend yields because management just wants everyone to be wealthy.

Typically, a stock has a high dividend yield because one key component of the dividend yield — the price — has fallen dramatically. Although dramatic price declines do happen because of the madness of crowds, most often they occur because something bad has happened: Earnings have fallen, sales have plummeted, or the product is infested with adders. In those cases, the company will probably cut the dividend, and things will go downhill from there.

One way to check if your company is headed for the viper pit is to look at the payout ratio, which is the company's dividends per share divided by its earnings per share. If the ratio is more than 100%, then the company is paying out more in dividends than its earnings, and the future of the stock and the dividend is grim.

Normally, older, more staid companies have higher payout ratios than younger, growing companies. For example, one popular way of picking good dividend payers is by following the Dogs of the Dow. These are the members of the 30 Dow Jones industrial average with the highest dividend yields. (High yields indicates low prices — hence the Dogs). The Dogs have an average payout ratio of about 60, according to Standard & Poor's Capital IQ.

In theory, you should buy the 10 Dogs of the Dow each year and replace them with new Dogs every year. You'll be buying high-quality companies at a relatively low price. The current Dogs: AT&T (ticker: T), Verizon (VZ), Chevron (CVX), McDonald's (MCD), Pfizer (PFE), General Electric (GE), Merck (MRK), Caterpillar (CAT), ExxonMobil (XOM) and Coca-Cola (KO). Average yield: 3.71%. You can find more information about the Dogs at www.dogsofthedow.com.

Another approach is to look for stocks of companies that have consistently raised their dividends over long periods of time. The Dividend Aristocrats are stocks that have raised their dividend every year for 25 years or more. You can get the full list at www.dividend.com. Or you can invest in funds that buy the Aristocrats. Those include the SPDR S&P Dividend ETF (SDY) and ProShares S&P 500 Aristocrats ETF (NOBL).

Vanguard's Dividend Appreciation ETF (VIG) takes its Aristocrats from Nasdaq stocks that have raised their dividends the past decade. For those with a global bent, the SPDR S&P Global Dividend ETF (WDIV) takes the Aristocrat approach for stocks worldwide.

Collecting dividend payers — or dividend funds — can be a good hobby, especially if you need some extra income from your portfolio. And, when interest rates are lower than a snake's sneakers, dividends can be a big help. Just be sure you pick your stocks carefully. The wrong ones can bite.