If you’re close to retirement, you’re probably considering a more conservative portfolio of investments—one designed to produce income rather than capital appreciation. Dividend-paying stocks can play an important part of that portfolio since they may offer lower risk and more stability while generating a steady and generally growing stream of income. In today’s low-interest-rate environment, stock dividend yields and bond interest rates are quite comparable, but stock cash dividends have the advantage of potentially growing over time. Increases in stock dividends also provide protection against inflation.
Lower Risk, More Stability
Companies that provide dividends are generally mature companies (think Johnson & Johnson or Coca-Cola). The companies tend to be stable and are generating enough profit that they are able to pay out dividends.
This stability helps make dividends a source of income especially appropriate for retirees. Dividend stocks are generally less volatile than stocks that don’t pay dividends. With dividend-paying stocks, you receive spendable cash (usually quarterly) without having to touch the principal. You could even reinvest the dividends to buy more shares, thus increasing your income in the future.
What’s more, because the companies offering dividends are, by and large, established companies with a solid foundation of profits, they tend to increase dividend payouts over time. Say, for example, you purchased shares of Coca-Cola in 2000. In September of that year, the dividend was $0.17 per share. Coca-Cola has since paid out quarterly dividends, now amounting to $0.35 per share. That’s money you would have enjoyed quarterly without having to do anything but collect it. And although—as the Coca-Cola example shows—initial dividend yields may not be high, over time the yield on your original investment could become 10–15% or more.
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Dividends as Income
Dividends can play an important role in a retiree’s portfolio—and it’s a role that has become more central in this era of low interest rates. As a retiree, you probably expect to withdraw around 4% from your retirement accounts each year. With a well-executed strategy, a good portion of that could come from stock dividends—say, 2–3%—thus leaving much of your principal intact.
Like any investment, dividend-paying stocks carry risk. The company could suffer severe financial straits, or the markets could hit an extreme point that affects the balance sheets of even stable companies, as in the housing crash and recession of 2007–08. There are always risks in investing, and it’s important to remember that past performance is no guarantee of future results. That said, it is rare that dividend companies have to reduce dividends. You will receive a steady, often increasing source of income that can act as a hedge against inflation and a buffer against volatile markets. That makes dividend stocks, and mutual funds that invest in them, a good investment for almost anyone.
If you’d like to see how dividend-stock mutual funds can play a role in your portfolio, please contact us.