Are you currently planning for retirement and wondering what are the best investment options for generating retirement income in your golden years? If you are doing your own investment research you are likely overwhelmed with options and opinions on what is the best way to invest your nest egg. If you are asking your 401k provider or financial adviser for advice then you are probably left with limited mutual fund options that will quietly hit you with fees and expenses and provide you with minimal annual income without resulting in you selling part of your position each year.
What you won’t hear from the investment community, at least not the investment community that earns a living providing investment advice, is that dividend stocks are king when investing for retirement. There are several reasons why compiling a diversified portfolio of dividend paying stocks is a highly rewarding and low stress option for retirement investing.
Dividends are Stable
Retirees seek investments that provide a fixed income that easily allows a person to budget what they will earn for the year so they can spend accordingly. This is why fixed income investments such as bonds, CDs, and annuities are such a popular choice in retirement, but many people don’t recognize this quality in dividend stocks. When you invest in a company like Consolidated Edison, who has paid a dividend since 1885 and has increased its dividend payment for the past 30 years, you can be assured you will be getting that dividend check every three months. The added bonus with many dividend stocks is that your “fixed” income will increase each year when the company raises its dividend payment (more on this later).
Dividends are Reliable
A retirement income source needs not only to be stable but also reliable. Just as you relied on a paycheck from your job on a set schedule, dividend stocks can be relied on to send you a check several times a year. You don’t have think about when you need to sell some of your investment in order to generate income, the payments are automatic and happen quarterly and even sometimes monthly. Just as death and taxes are certain, so are your dividend payments when you are invested in a high quality company.
Dividends are Predictable
Dividends are predictable in the sense that you can easily predict the income you will generate for the year when invested in a dividend stock. Individuals who focus on total return and not income are forced to decide when to sell in order to generate income. Do they sell enough at the beginning of the year to provide them with the necessary income needed for the next 12 months? What if the market is down, do you sell just a little in the hopes that prices will go back up providing a better selling opportunity later in the year.
When invested in dividend stocks retirees don’t have to fret about day-to-day price fluctuations of their investments. By carefully selecting companies with sustainable growing dividends and long histories of dividend payments, an increase or decrease in overall price becomes much less of a concern. If a stock’s price drops 20% but its dividend remains constant, that price drop has no affect on the dividend income being produced by the stock. A stock’s dividend is much easier to predict than its price and a dividend exists independent of the market price.
Take for instance investors of Target Corporation in 2014. Those looking for price appreciation were in for a wild ride as prices fluctuated throughout the year. But those who invested in the stock for dividend income generation received a nice dividend payment and a 21% increase (quarterly dividend increase from 43 cents to 52 cents) in income thanks to the company’s annual dividend raise. These income investors could happily ignore the volatile price fluctuations of the stock knowing that the underlying fundamentals of the company all but guaranteed them their dividend payments.
Dividend Stocks Provide Inflation Insurance
Possibly the most overlooked benefit of dividend income investing is the power dividend growers have in fighting off the affects of inflation. The term “fixed income” is used far too often when discussing retirement investing and planning. Fixed income suggests you should be able to decide today how much income you are going to need each year of retirement. But because of inflation we know that our expenses are not going to be fixed, so we should not plan for our income to be either. If you plan to withdraw the same amount from your retirement account annually then you will be losing purchasing power each year due to inflation. And many people underestimate the effect inflation has on their retirement plans.
Consider you are someone who is supporting a $60,000 a year lifestyle in retirement. At an average inflation rate of 3%, in order to have the same buying power in the future that you have today you will need:
- $80,0000 a year in 10 years
- $108,000 a year in 20 years
- $145,000 a year in 30 years
Bonds, CDs, Annuities all provide income payments, but none of them will be providing you with an annual raise. Each year you will lose purchasing power when you receive the same fixed amount from one of these investments. A portfolio of dividend growers on the other hand can protect you from the deteriorating affects of inflation. In fact, a focus on dividend growth within your retirement portfolio can provide significant improvement in buying power each year. For instance, Coca-Cola has provided a five year average dividend growth rate of over 8%, Exxon Mobil has averaged increases of 10% and Microsoft has averaged a whopping 17%. Income investors with companies like these in their portfolio the last five years haven’t lost any sleep worrying about inflation.
So why don’t you hear more about dividend investing in retirement? Its because financial companies aren’t making much money when investors do this. They don’t collect mutual fund fees, load fees or sales fees. Because your portfolio remains fairly static they don’t generate many buy/sell commissions. And when a company pays a dividend, the full amount goes to the investor, the middle man doesn’t get a piece.
There does take investment knowledge in order to build a dividend focused retirement portfolio. There are plenty of companies that pay a dividend but do not commit to increasing their payment each year. Others pay a dangerously high dividend that looks appealing to yield hungry investors, but the health of that dividend payment may be in jeopardy. Investment professionals will try to point out that dividend investing involves greater risk vs their recommended investment choices. But when you build a diversified portfolio of companies that have a long history of paying and raising its dividend, and have underlying fundamentals that reinforce the health of the dividend payment then you eliminate a great deal of that perceived risk and will be rewarded with a safe, reliable, and growing income stream.
Disclosure: The 4 Percent Portfolio currently recommends Microsoft and Consolidated Edison.
Would you like to build a stable and reliable income producing portfolio that will increase your income each year. The 4 Percent Portfolio was designed just for that purpose. Investors who follow our Portfolio will achieve a well diversified portfolio of established dividend stocks with long histories of paying and increasing their dividend payments. Let us show you how to build a better retirement portfolio. Learn More