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Dividend-paying stocks can help protect your porfolio if the market takes a turn

The occasional road bump is to be expected, and that’s exactly what investors have been getting lately. While the market continues to edge upward, overall it’s been a pattern of setting new records, followed by periodic retreats. Take what happened in early July: Jitters over the rising rate of foreclosures, coupled with a few surprise earnings warnings, prompted a one-day drop of 148 points in the Dow. Then over the next two days the market shot up 360 points.

So what’s an investor to do? In turbulent times, many investors like to bank on the reliability of dividend-paying stocks. The term isn’t bandied about much anymore, but these so-called “widow-and-orphan stocks,” were customarily well-established companies that posed little risk and paid a regular dividend. With people living longer and planning for retirements that could last for decades, more investors are taking an interest in generating a reliable income stream from their stock portfolios.

“Anything that pays dividends is putting more money into my pocket. It just makes sense,” says Sharon Lay. Lay says she adds a minimum of $100 a month to her brokerage account with “However, one has to think long-term–these are stable growth companies, they are not going to be ricocheting up and down daily.”

For starters, consider that dividend payments–a distribution of corporate earnings to shareholders–are a sign of corporate stability. After all, a company has to have a certain measure of financial health before management would choose to pay out profits rather than reinvest in the business. Also, management wants to avoid ever having to lower the dividend, which could be interpreted as a signal that there are problems. An added plus: Historically dividend-paying stocks have outperformed non-dividend paying stocks according to Ned Davis Research.

“As a single woman, I’m able to heavily invest in my portfolio; however, I want at least some guaranteed income,” says Lay, who is a product manager for Motorola in Arlington Heights, Illinois. For the last seven years she’s taken full advantage of Motorola’s employee stock purchase program that allows employees to buy stock at a 15% discount. Though shares are currently well off their high, they carry a dividend yield–the amount of the annual dividend divided by the current stock price–of 1.1%. Some of the holdings in Lay’s portfolio include AT&T (T), which offers a 3.6% yield; amusement park company Cedar Fair (FUN), which doles out 6.6%; and golf equipment maker Callaway Golf (ELY), which sports a dividend of 1.6%. By comparison, the average dividend yield of the S&P 500 is 1.6%.

“On a historic basis, dividend-paying stocks have turned out to be the real key to building wealth,” says William Young, president and chief operating officer of Buford, Dickson, Harper & Sparrow, a St. Louis-based institutional money manager. But putting their track record aside, another driver of the increased interest in dividends was a 2003 change in the tax laws that reduced the maximum federal tax rate on qualified dividends to 15% for most investors. At the moment, a sunset provision means

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