Suze Orman Money Matters

The half-point drop in the Federal Funds rate in September certainly had an immediate (if temporary) positive effect on a jittery stock market. But on the flipside, it's talking a cut out of yields on bank CDs, savings accounts, and money markets.

Already, ING has reduced its savings account yield from 4.5 percent to 4.3 percent; HSBC's went from 5 percent to 4.5 percent. And the 5.05 percent offered by Emigrant Direct is now down to 4.75 after Ben Bernanke announced the rate haircut.

A Cushion in Volatile Times

Those are still nice yields, but if further easing is in store, they're going to head further south. While your emergency savings and short-term savings belong in these super-safe investments, I think now is a great time to revisit the topic of dividend stock investing -- not as a substitute for your cash investments, but as a complement.

The 2 percent to 4 percent or more you can get on many solid dividend stocks is a great way to generate income from a portion of your money that's earmarked for the stock market.

Dividends are also a nice cushion in a volatile market, as most large firms that pay a dividend to shareholders are loath to stop the practice. If you stick with solid, established companies that can easily manage their dividend payouts, you're as close to a sure thing as possible in the unpredictable world of investing.

Dividends Made Simple

The stock price may go up, it may go down. Market volatility will determine that. But the dividend payout from the likes of Johnson & Johnson and Bank of America isn't so fickle; as I said, it's rare for a solid -- and I emphasize solid -- company to suddenly reduce or rescind its dividend payout.

Knowing you can count on a dividend payout no matter what can make it easier to weather a market downturn. And keep in mind that over the past 60 or so years, about 40 percent of the total return for stocks in the Standard & Poor's 500 came from the dividends paid out by the stocks.

A quick table-setting for any dividend newbies out there: A dividend is a cash payment made to shareholders of a company on a regular schedule, typically quarterly. As a shareholder, you can take the dividend as cash or, in many instances, you can opt to have the dividend reinvested in additional shares of the stock. A stock's dividend payout per share divided by its stock price is called its dividend yield.

Right now, the dividend yield for the S&P 500 stock index is hovering around 1.7 percent. But some well-known companies sport much higher yields; General Electric has a 3 percent yield, while Bank of America is at 4.7 percent.

Risky Payoffs, Less Taxes

Dividends are typically the domain of established, well-off companies that have sufficient earnings to issue a payout. But "typically" is important here -- not all dividend payers are on super-strong footing. Some companies stretch to attract investors by offering big dividend payouts that they can't sustain over long periods.

Obviously, those aren't the types of dividend-paying stocks I recommend. I'm more interested in companies that have a long history of sustaining and increasing their dividend payouts, rather than a company struggling to make an 8 percent payout when it doesn't really have the cash or business model to support that over the long term.

It's also important to recognize that a high yield is sometimes a function of a very low -- as in troubled -- stock price. Remember, the formula is per share dividend income divided by per share stock price equals yield. If the stock price plummets, the yield goes up. But the goal is to get the steady income stream without running the big risk of the stock tanking.

If a stock has a huge dividend yield, be very cautious. Do your homework to make sure you understand the underlying risk not just of maintaining the dividend, but more important, for the stock itself.

There's a nice tax break these days on the dividend income payout, too. One of the raps against investing in dividend stocks used to be the fact that the payout was taxed at your ordinary income tax rate; for the well-off, that could mean a 35 percent tax bite on all dividends. But a tax law change a few years ago now taxes most dividends at a far more reasonable flat rate of 15 percent.

A Diversified Dividend Strategy

You can, of course, invest in individual stocks of companies that issue dividends. But unless you have the time and acumen to properly evaluate and monitor your holdings, and the ready cash to build a portfolio of at least 15 or more stocks, you're better off sticking with an ETF or low-cost mutual fund that specializes in dividend-paying stocks.

The granddaddy of the dividend ETFs is the iShares Dow Jones Select Dividend (DVY). Its current 3.28 percent yield is nearly double the payout of the S&P 500. This ETF screens for 100 stocks that have strong trading volume and that have raised their dividends -- and never reduced the payout -- -in the past five years. Stocks that use more than 60 percent of their earnings to cover the dividend payout are ruled ineligible.

The current high yield for DVY is in part a function of its heavy weighting in financials (40 percent); thanks to the subprime mess, the stock price for many of those financials have struggled this year.

For a more diversified dividend approach, check out Vanguard High Dividend Yield (VYM; 2.8 percent yield). It holds about 500 stocks and doesn't have such large-sector bets as DVY; financials currently account for about 25 percent of this ETF's assets. The Vanguard offering also has a nice fee edge. Its 0.25 percent annual expense ratio is even better than the not-so-shabby 0.40 percent fee for DVY.

Another interesting dividend ETF is the Wisdom Tree Total Dividend ETF (DTD; 2.2 percent current yield.) It charges a low 0.28 percent expense ratio and follows a different investment path that ranks its universe of dividend-paying companies (over the past 12 months) by their anticipated payouts for the next 12 months relative to the payout rate for the overall index.

Mutually Beneficial

If you prefer mutual funds to ETFs -- the right move if you're making frequent periodic investments because you don't want to constantly pay the brokerage commission charged on ETF trades -- you have plenty of options.

Again, costs matter. The Vanguard Value Index (VIVAX; 2.37 percent yield) levies a stingy 0.21 percent expense ratio.

Though it isn't expressly on the prowl for dividends, the universe of large-cap value stocks tends to be home to many dividend-paying companies. T. Rowe Price Equity Income (PRFDX; 1.8 percent yield) seeks out large-cap value stocks with an eye toward companies whose yield exceeds that of the S&P 500. Its 0.69 expense ratio is a bit higher than the other options I've discussed here, but it's well below the 1.5 percent average for actively managed funds. And T. Rowe is a great place to invest if you're on a tight budget: You can invest as little as $50 as long as you agree to continue making periodic payments through its Automatic Asset Builder plan.

To conduct in-depth research on top high-yielders, go to Yahoo! Finance's Mutual Funds Center and ETF Center.