There are many guidelines on how to withdraw your savings when you retire (4% rule, 25x rule, etc.). Dividend stocks can generate retirement benefits. Dividends can provide a steady stream of cash without deducting the principal. But there are pros and cons to retirement dividend stocks. are they right for you?
Most retirement savings strategies dictate investing in stocks when you’re young and bonds when you’re nearing retirement. For example, the “rule of 100” says that you should subtract your age from 100, and the answer is how much you should invest in stocks. This means that a 25-year-old should invest 75% of his assets in stocks and 25% in bonds. At age 55, he should invest 45% of his wealth in stocks and just over half in bonds.
However, these rules make many assumptions, most of which are based on 1980s investment wisdom. One assumption is that stocks are much riskier than bonds, and that bonds provide a steady income rather than just rising prices.
In fact, over the last 30 years, stocks have become significantly less risky for retail investors who can invest in funds that own stocks in diversified portfolios. Dividend stocks in particular can be an interesting solution for retirees, especially those interested in increasing their regular income.
What are dividend stocks?
Dividend stocks are stocks of companies that regularly (usually quarterly) pay out a portion of their profits to investors. Not all stocks are dividend stocks because not all companies pay dividends on stocks.
Investopedia defines dividends as: “
15 Pros and Cons of Dividend Stocks
When it comes to retirement, passive income is the way to go. Passive income is money that comes in with little or no work done.
Dividend income is flexible. you can:
- An ideal reinvestment if you are focused on accumulating wealth.
- Store dividends in a separate asset class. For example, it is ideal if you need to increase your emergency funds.
- Use dividends as is often the plan for retirees.
3. Pros: Dividend stocks are usually also value stocks (relatively stable and safe companies)
Stocks that pay dividends are stocks in companies that make a profit. That means they share a stable profit with their shareholders and probably won’t go out of business anytime soon. This makes it a safer and less risky option for retirees.
Value stock definition: Value stocks are priced low relative to the company’s income and dividends paid. (The opposite of value stocks is growth stock – Like some tech stocks. Growth stocks typically don’t pay dividends, but grow rapidly. )
Benjamin Graham, the “father” of value investing, said as far back as 1949 that investors should buy shares in profitable companies that have maintained stable dividends for at least 20 years. . These companies have paid steady dividends for at least 50 years, most of which you’ve known since you were born.
- The Coca-Cola Company (dividends since 1920)
- Colgate-Palmolive Co. (dividends since 1895)
- Hormel Foods Corp. (dividends since 1928)
- Johnson & Johnson (dividends since 1963)
- Lowe’s Companies (dividends since 1961)
- Stanley Black & Decker (dividends since 1876!)
Value stocks that pay dividends are sometimes called “dividend heroes.” Because we are a reliable provider of value in a market that is a roller coaster that rises and sinks quickly.
Dividend stocks are a great concept. Who wouldn’t want to share the profits of a time-honored company and earn passive income? It’s about making what looks like not a great investment.
Dividend stocks provide a stable income, but the stock’s value can also rise over time. Therefore, dividend stocks have a double advantage. Your money can potentially grow in two different ways.
However, it’s important to note that the stock prices of companies that pay dividends typically grow more slowly than other types of stocks.
The future is unpredictable and speculation is unwise at any stage of your investment life. However, it is not uncommon for dividends to increase over time. These increases will help your retirement income keep up with inflation.
Forbes recently published a list of 10 Inflation Outperforms Dividend Stocks.
7. Cons: Individual stocks, even value stocks, are risky
For decades, General Electric has been a “blue chip”, a reliable, stable dividend payer. If he had bought General Electric stock for $100 in 1970 and sold it in 2016, it would have returned more than 21% annually, with a final net worth of $784,703.30 (assuming dividends reinvested). increase.
Blue chip definition: Blue chip stocks are stocks of industry leaders in mature industries that generate stable earnings and dividends.
on the other hand…
The Great Recession forced General Electric to sell its profitable financial services division, revealing the company to be an unnecessarily large and complex organization with many hidden liabilities.
The CEO from 2001 to 2016 stepped down, and less than two years later, another replacement stepped in and put the ship right. Then the coronavirus crisis demolished one of GE’s last profitable businesses: aero engines.
Today, GE’s stock is a fraction of what it was worth six years ago (significantly lower than it was 15 years ago), and its dividend has been significantly cut.
You may be buying stocks because you want the expected dividends, but you’re still putting money into the investment and don’t want to overpay. You need to make sure your stock represents an appropriate value.
If you want to invest in dividend-producing stocks, it’s important to have a fair amount of knowledge about investing or have a good advisor by your side.
New Retirement Advisor: NewRetirement Advisors provide free access to Certified Financial Planners™ Professionals who can collaborate with you using NewRetirement’s online tools and more. We can collaborate on asset allocation strategies for a fraction of the cost most investment advisors charge for assets under management.
Book a free Discovery Session to discuss your needs.
9. Cons: Dividend stocks are usually in utilities, banking, and older industries
Many dividend stocks are in sectors that make a lot of money in products people need, such as energy, financial services, and consumer goods. While this can generate a lot of cash income, it can also mean that your company has a fairly narrow range.
When the oil industry crashed in early 2020, formerly reliable dividend stocks like ExxonMobil cut their dividends in half. If the dividend stocks were all oil company stocks, you would have lost a significant portion of your income.
Consider your diversification needs before investing.
10. Pros: Mutual funds and ETFs can diversify dividend stocks
There are many dividend and income focused mutual funds and exchange traded funds (ETFs). Vanguard, Charles Schwab, and BlackRock all offer high-dividend ETFs and mutual funds that are as broad as the top dividend stocks of the S&P 500 index or as narrow as real estate companies. increase.
Dividend yields for these funds average 3% and can reach as high as 9%. And the risk of individual companies going through hard times is mitigated by other companies in the fund.
You can also diversify sector risk by owning a few sector ETFs or mutual funds, or an index fund focused on dividends but owning hundreds of companies across all sectors. increase.
Note: Know and understand the costs associated with dividend-producing funds. They are usually higher than the fees inherent in regular funds.
11. Cons: Stocks are generally riskier than bonds and other fixed income assets
The fate of individual companies depends on many factors, and no one but a professional stock analyst can do enough research to pick long-term winners and losers.
On the other hand, the most reliable government bonds, US Treasuries, are considered “risk-free.” This is because no one in the world expects the US government to default on its debts. That’s what U.S. Treasuries are all about.
12. Cons: Asset allocation can be hard to figure out
What is the right mix of dividend-producing investments and hedging against market volatility? Unfortunately, it depends on your risk tolerance.
Having trouble figuring out your asset allocation? You may want to work with a financial advisor.
New Retirement Advisor: NewRetirement Advisors provide free access to Certified Financial Planners™ Professionals who can collaborate with you using NewRetirement’s online tools and more. We can collaborate on asset allocation strategies for a fraction of the cost most investment advisors charge for assets under management.
Book a free Discovery Session to discuss your needs.
13. Pros: Dividends have tax benefits
Dividends paid by companies can be classified as either income or capital gains.according to National Tax Agency“Ordinary dividends are taxed as ordinary income, but eligible dividends meeting certain requirements are taxed at a lower capital gains rate.”
The difference between the two rates can be large. If your regular income puts you higher in US tax rates, pay Uncle Sam 37 percent (more than a third). On the other hand, if you own a company that pays eligible dividends, the top tax rate on that money is only 20%. Especially if you reinvest that money to buy more stock, the difference in returns over a decade can be huge.
You can conduct research to see which companies pay qualifying dividends and which do not.rule According to the IRS that is:
- Dividends must be paid by a US company or a qualified foreign company.
- Dividends are not listed by the IRS as ineligible.
- Meets required dividend holding period.
As with most equity investments, an easy way to ensure that dividend stocks pay eligible dividends is to buy them in bulk in an ETF or mutual fund (Vanguard has a list of eligible dividend ETFs). I am here.)
Even if you don’t own a company that pays eligible dividends, if you own those companies under a Roth IRA or Roth 401(k), your dividend income is tax-free. And if you’re considering a traditional IRA or 401(k) Roth conversion, the NewRetirement Planner can help you strategize the best time to convert and minimize your tax burden.
Some experts criticize dividend-producing stocks because dividend payments are double taxed. Taxes are paid by corporations and you, the investor, must pay personal income tax on dividends earned during a particular tax year.
Dividends are not guaranteed by the company. We may change or even abolish our dividend policy.
Modeling dividend investments in NewRetirement Planner
Dividend stocks can be an important source of income after retirement. You receive a stream of income and if you have a dividend champ in your Roth account, there are tax benefits on the money you start.
As a NewRetirement Planner account, you can model your dividend-producing investments. If you plan to use your dividend income as a regular source of income (rather than reinvest it), you can enter it as passive income and model it in your tax treatment.
Either way, adding dividend income to your retirement plan can increase your retirement income without using up your principal.
