Another reason why the high-dividend investment strategy is appealing is that many of the companies that pay high dividends are larger and established, making them less risky.

During a recession or bear market, investors typically flock to these stable securities, because the income received from dividends can offset or alleviate some of the value lost in the stock price."

Why dividends make better sense

So do dividend-paying stocks really make better investments than their non-dividend-paying counterparts? Well, like anything in this world, there are various schools of thought on this matter, and we have seen that dividends can be reduced or suspended, as the recent decisions by Dow Chemical  (NYSE:DOW) and Freeport McMoran Copper and Gold (NYSE:FCX)..

Some investors believe it is better to invest in non-dividend paying stocks, because the earnings can be reinvested back into the company to generate more growth or to make acquisitions.

Also, earnings that are paid out in dividends are taxed twice, once at the corporate level and again for the investor. Reinvested earnings are only taxed at the corporate level, allowing more cash to generate higher compounded returns.

Here's a point that does resonate with me, and  that's the argument that dividend-paying companies are superior investments because they show that management is commitment to its shareholders. Paying dividends takes cash out of the hands of management -- which can't always be trusted to make decisions with the shareholders' best interests in mind -- and gives it directly to investors.

On the other hand, do I want to invest in a company who has the kind of management that I can't consistently trust to look after my best interests as well as the companies?

Sustainable Dividends

For those who see this income as a benefit, there are two important things to keep in mind. First, investors must understand how much a company can "afford" to pay in dividends. If a company is paying out unsustainable dividends, it's only a matter of time before the dividend will be cut. This is one of the risks of investing in high-dividend equities instead of bonds. People who invest in bonds are guaranteed a coupon payment until the bond matures. In contrast, equity investors have no such guarantee on their dividends, while companies have the freedom to cut or cancel their dividend payments at any time.

To reduce their risk, investors must calculate the company's free cash flow to ensure that it exceeds the amount being paid out in dividends. Free cash flow, unlike net earnings, tries to measure the amount of cash a company has left over after all of its reinvestment needs have been met. When a company's dividend payout exceeds its free cash flow, it is not only reducing its asset base, but it may not be reinvesting enough to sustain itself. Over an extended period of time, this can increase investors' risk.