The historically low interest rate environment has led me to look at dividend-paying stocks as an alternative to bonds for income.  Dividends have historically accounted for 40% of the returns from investing in stocks, while too high of a dividend can also be a sign of trouble. For example, shares of BP (NYSE:BP) offered a trailing 12-month dividend yield of 9%. It turned out the dividend was higher because the market was accurately anticipating the dividend would be cut. New Century Financial, a subprime mortgage REIT, offered a dividend of 18%; unfortunately, the firm filed for bankruptcy when the housing bubble burst.  There are some questions that investors need to ask about this. The first is will dividend-paying stocks decrease my portfolios total return? If so, Id be better off selling shares of stock regularly for income. The second question is, is it logical, net of taxes, to realize dividends from my portfolio to meet my income needs? And finally, can I purchase dividend-paying stocks while avoiding the landmines?  The most logical place to look for dividend income is in large-cap value stocks. The table below shows the top dividend paying large-cap value exchange-traded funds and the iShares S&P 500 Value Index (NYSE:IVE) as a benchmark. Over the last three years, every one of these ETFs lost less than the benchmark. Using the Morningstar rating to measure risk versus return, all but one of these ETFs outperformed the benchmark. This demonstrates dividend-paying stocks wouldnt hurt total return; rather they would likely improve it.  At present there are currently no negative tax implications from realizing dividends. Dividends are currently taxed at a maximum of 15%, the same as long-term capital gains. Interest income is taxed at the higher ordinary income tax rates.  Using alpha offers an accurate measurement of the effectiveness of each ETF's approach to identifying dividend-yielding stocks and avoiding the landmines (the higher the alpha, the better). In addition, using Morningstars rating helps determine how each ETF stacks up against the others based on risk-adjusted returns.  Record of Historical Dividend Increases  One approach to developing a portfolio of sound dividend-paying stocks with low risk of stepping on a landmine is selecting companies with a long-term record of annual dividend increases. Two ETFs, Vanguard Dividend Appreciation (NYSE:VIG) and PowerShares Dividend Achievers (NYSE:PFM), screen the universe looking for stocks with a record of having increased dividends for a minimum of 10 years, while SPDR S&P Dividend (NYSE:SDY) raises the bar to companies with a minimum of 25 years of annual dividend increases. These approaches seem logical. A company must be pretty stable to raise dividends regularly for 10 or 25 consecutive years. Based on the alpha and Morningstar ratings, the Vanguard ETF and SPDR S&P Dividend ETF are particularly attractive.
There are some pitfalls for investors looking for income from dividends. Here are some ETFs to avoid those.