Dividend stocks are nice, but they aren't foolproof

— -- Q: I've heard stocks that pay dividends are the best. Is that true? And if so, can you recommend some good dividend paying stocks?

A: When the market goes into freefall, investors get a reminder of how important dividends are.

It's encouraging to get quarterly cash payments, even while the overall value of your portfolio is in freefall.

Don't, however, make the mistake of thinking that all stocks that pay dividends necessarily outperform the stock market. That's not always the case.

The recent downturn provides a brutal reminder that simply picking stocks that pay big dividends isn't a guaranteed way to profit. For instance, many dividend-hunting investors loaded up with bank stocks in 2007 and 2008 when their dividend yields soared to 10% or more. Unfortunately, these investors wound up losing 90% or more on their stocks, more than offsetting the dividends.

With that said, dividends do offer some protection. Just not as much as you might expect. In researching your question, I took a look at the 100 stocks in the Standard & Poor's 500 with the highest dividend yields. On average their yield was 7.3%. The stocks fell between April 24, 2008 and April 24, 2009 by 40.3% for a total loss of 33%.

Meanwhile, for the stocks in the S&P 500 at large, the average dividend yield was just 3.6%. But between April 24, 2008 and April 24, 2009, the stock prices fell 37.3% for a total loss of 33.7%. That means that both the top dividend paying stocks and the S&P 500 at large had basically identical performance.