The lure of dividends

But it shouldn't be too difficult for high-quality stocks to beat 4.4%, particularly if they pay dividends. Yields of many stocks are extraordinarily generous and, unlike CDs, stocks offer potential for appreciation. Edward Hemmelgarn, president of Shaker Investments, in Cleveland, notes that shares of Bank of America yield 4.4%, while the bank's five-year CDs pay 2.75%. In a similar vein, the stock of Verizon Communications yields 5.2%, while the Baby Bell's ten-year bonds yield 4.9% to maturity. Keep in mind that the maximum federal income-tax rate on dividends is 15%. Interest on bonds and CDs, however, is considered ordinary income and is taxable at a maximum rate of 35%.

Another way to pad your gains is to emphasize stocks by style, an ideal approach if you invest almost entirely in mutual funds. The best group in 2006 should be shares of fast-growing, big companies. We made the same call for 2005 and, although the group didn't perform as well as we had hoped, it narrowed the gap with other U.S. stock categories. If higher interest rates and energy prices weaken the economy, investors will probably shift money into companies that can prosper under adverse conditions. Moreover, the behemoths, exemplified by names such as Citigroup, General Electric and Johnson & Johnson, are generally trading at uncommonly low price-earnings ratios relative to the overall market and offer generous dividends. "The 50 largest stocks in the U.S. are cheaper today than they were in 2001," says Jeff Everett, chief investment officer of the Templeton mutual funds. A diversified way to play the revival of big-capitalization growth stocks is through iShares Russell 1000 Growth (symbol IWF), an exchange-traded fund that owns the faster-growing companies in the large-company-oriented Russell 1000 index.

You can also improve results by trolling for timely sectors. Good ideas include health care, heavy-construction gear and technology. Strong earnings prospects and breakthroughs in research should boost health-care stocks (although not necessarily those of big drug makers). And even if consumers retrench, they'll still spend to stay healthy. Cash-rich companies are likely to boost spending on technology to improve productivity, and governments will spend enormous amounts on highways, bridges and other construction projects. (For eight stocks we like for the coming year, see page 40.) You can also play each of these sectors with ETFs. IShares offers both health-care (IYH) and technology (IYW) ETFs. For a construction-related ETF, check out the PowerShares Dynamic Building and Construction Portfolio (PKB).

Seasoned investors know that you don't give up on stocks just because of one year's frustrating performance. Good companies make money more often than they lose it, and so should their stockholders. Quality wins out eventually -- and there are plenty of high-quality stocks available at reasonable prices. That's Mark Feldman's approach to selecting stocks. Most mornings, Feldman leaves his home in the St. Louis suburb of Kirkwood and takes his laptop computer and several newspapers to Starbucks. There, the 59-year-old semiretired math professor tends to a portfolio of 20 stocks and several mutual funds that belong to his wife, Susan. She's a former financial executive who took a company buyout package in 2000. The Feldmans need to withdraw a few thousand dollars a month, so Mark puts as much emphasis on maintaining the portfolio's value as he does on shooting for large gains. Yet he says he earned 10% in 2005 through mid November and has done at least that well every year since he established the portfolio in 2001.

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