You got a BIG pay raise in 2014! Common stocks that pay cash dividends to their shareholders may regularly increase the cash dividends as cash profits in the company increase. Investors benefit whether owning the company shares directly or indirectly thru mutual funds.
Investors in the Vanguard Total Stock Market Fund received income dividends in 2014 that were 18% higher than 2013. Dividends in 2014 were 44% higher than 5 years earlier in 2009 for an annualized growth rate of 7.6% per year, well ahead of inflation. Investors in the Vanguard 500 Index Fund received income dividends in 2014 that were 22% higher than 2013. Dividends in 2014 were 32% higher than 5 years earlier in 2009 for an annualized growth rate of 5.7% per year, also well ahead of inflation.
Dividends are not guaranteed and can fluctuate and many companies cut dividends in 2009 and 2010 following the global financial crisis in 2008. Part of the strong growth in 2014 stemmed from companies restoring and increasing previously cut dividends.
The important lesson is that investors should look at stocks as an important source of income, especially given the potential for cash dividend income to increase. Bonds are typically considered first for income. In today’s low interest rate environment, U.S. large company stocks, as measured by the Vanguard 500 Index Fund Admiral Shares, actually have a higher current yield of 1.95% compare to 1.91% for the Vanguard Total Bond Market Admiral Shares, which represents U.S. government and corporate bonds. While stock and bond current yields are nearly identical, the potential for stocks to increase cash dividends warrants consideration for income investors. Of course, stocks can fluctuate more wildly in price than bonds, so investors are prudent to include bonds in their portfolio to cushion total portfolio volatility.
Did you know that there is one savings/investment account (and only one) that offers triple tax benefits? A Health Savings Account offers tax deductible contributions, tax-free investment earnings and tax-free withdrawals for qualified medical expenses. This triple tax benefit trumps an IRA, 401k or Roth IRA. Do you think Medicare coverage for retirees will be better or worse in the future? If you’re like me and think it will be worse, a highly recommended strategy is to contribute to a Health Savings Account the current annual maximum of $6,650 for family coverage or $3,350 Single (and add $1,000 if you are 55+), do NOT withdraw from the account to reimburse yourself for current medical expenses, and allow it to accumulate for your retirement years. There are important caveats: a Health Savings Account has to be linked to a high deductible health insurance plan thru your employer or individual coverage and, in reality, your cash flow has to be strong enough to make the contribution and not withdraw it for current medical expenses. One may consider adjusting 401k contributions to a limited degree.
As always, please contact us with any questions or news or comments.