Retiring boomers are looking for ways to generate income without eroding their assets. One approach is to invest in dividend-paying and rising dividend-paying stocks and funds.
Dividends are taxable payments to shareholders generated by company profits and paid quarterly as determined by the companies’ boards of directors. Dividends can increase or decrease from quarter to quarter, but boards are reluctant to reduce dividends as that signals a decline in the health or stability of the organization. People tend to sell off stocks that reduce their dividends, which happened to banks during the Great Recession of 2008 and 2009. Under certain conditions companies have had to suspend their dividends, as British Petroleum (BP) did following the Deepwater Horizon oil spill in the Gulf of Mexico in 2010. Financial and energy companies generally reactivated their dividends following the Great Recession, which has attracted institutional as well as private investors.
Dividend stocks and funds
A variety of investment vehicles specialize in dividend stocks, including exchange-traded funds (ETFs), mutual funds, and individual stocks. Funds that invest in rising dividend-paying stocks hold companies that have long-term track records of increasing their dividends year over year, sometimes for as long as 15 or 20 years—Franklin, for example, offers a rising dividend fund.
Energy companies, in particular utilities generally have good track records for paying dividends consistently. Utilities can serve as an alternative to bonds. You’re getting paid like bonds, but bonds lose value when they become too expensive; they don’t keep pace with inflation. When bonds are over-priced, the investor can switch to utility company stocks that pay dividends.
Tobacco companies might not be an attractive investments for many people, but they do maintain a record of rising dividends, principally due to the payments they are making on the long-term settlements resulting from the cases brought against them for harming peoples’ health. For example, the Altria Group, producers of Marlboro, has been paying a dividend of about 7.5 percent.
The alcohol industry also has a good dividend-paying record. Diageo, a British company based in London, and one of the world’s largest suppliers of alcohol, paid around 2.00 percent dividend in October 2021. While the rate does not rank among the higher yields, at slightly less than $4.00 per share, that’s still a substantial dividend.
The power of dividend-paying stocks in a retirement portfolio is in providing income without reducing overall portfolio value. A rule of thumb says that retirees should draw income from their portfolios at a rate of about 4 percent per year. If the portfolios consist of stocks and funds that generate dividends of 4 percent or more annually—we target funds and stocks that pay minimally a 4 to 5 percent annual dividend—then the retiree can make that 4 percent drawdown without reducing their overall portfolio value.
The benefit for income-related investors is not having to sell the stock to generate income; you just use the dividend as part of your supplemental income. That also allows the stock to appreciate in value, the end result being a portfolio that grows as opposed to declining in value.
A steadily increasing dividend is a sign a company is healthy and stable. That typically bodes well for the company’s stock price. Of course there is no assurance markets will rise, but investors in dividend-paying and rising dividend-paying stocks and funds don’t generally have to concern themselves with the markets. As such, those stocks and funds are important tools in a client’s investment toolbox, especially for baby boomers in retirement or getting ready to retire who need income but don’t want to draw down their assets.
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