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Dividend investing for retirement income

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June 22nd, 2016

The key to a secure retirement is generating income while not working. You can do that with Social Security, pension payments, and distributions from retirement savings plans. Another way to create income in retirement is by investing in stocks that pay dividends.

“It’s a good strategy during retirement because dividend stocks are ‘income stocks,’” says Abhishek Gupte, subject matter expert at Dividend.com, which provides research and analysis on dividend stocks. “More than 70% of the market return in the last 50-odd years is not through capital appreciation, but through dividend payouts. When you are retired, you don’t want to take excessive risk and invest in growth stocks or value stocks.”

How it works

It’s helpful to understand how dividend investing works. When corporations earn profits, they can choose to reinvest those funds into the company or distribute a portion to shareholders in the form of a dividend.

“From an investor’s perspective, think of a dividend as a reward for your trust and confidence in a company, a mutual fund, or exchange-traded fund,” explains Wisconsin financial planner Chad Nehring (conceptualadvisors.com). “It is generally a share of the profits in a company or group of companies, but, like profits, dividend payments are not guaranteed and can be lowered or eliminated.”

Robert Johnson, president and CEO of The American College of Financial Services (theamericancollege.edu), says investors typically look for stocks with a relatively high dividend yield, which is calculated by dividing the annual dividend by the current stock price. 

“For instance, Coca-Cola has an annual dividend of $1.40 and is selling at $46.10 per share, so its annual dividend yield is 3.04%,” Johnson explains. “[Dividend investing] is also a good idea, because investing in dividend-paying firms can provide the investor with two sources of returns—cash dividend payments and increasing share prices.”

Gupte says to look for stocks that have healthy yields as well as low beta (volatility), healthy payout ratios, and modest earnings growth estimates. A winning dividend-investing strategy will hit all of those metrics.

“The crux of this strategy is earnings and expected earnings growth,” Gupte says. “If there are no earnings, there will be no dividends that will be paid, and if there is no earnings growth, the payouts aren’t going to increase going forward.”

One good place to start looking for dividend-paying stocks is the utilities sector, which Gupte says has a very low beta and a long history of paying dividends. Two of his favorite dividend stocks are Aqua America, Inc., and Waste Management, Inc.

The current market conditions make dividend investing attractive, according to Johnson. He says that when bond yields are very low, as they are in the current market, high-dividend-yielding stocks can be an attractive alternative to bonds. 

‘Ruler stocks’

Johnson recommends investing in companies that have consistently raised their dividends for a number of years. He particularly likes Genuine Parts Company, which has increased its dividend for 60 years and offers a 2.7% yield. He says companies like Johnson & Johnson, Colgate-Palmolive Co., The Procter & Gamble Company, and The Coca-Cola Company are all “ruler stocks.”

“This term refers to the fact that if you placed a ruler from the starting point in the series of dividend payments to the ending point in the series on a graph, most of the points would be very close to the ruler,” Johnson says. “Ruler stocks are ideal for dividend investors because of the consistency in the dividend growth.”

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