Your financial goals are personal to you. The information in this article is for educational purposes only. Retirement Living does not offer advisory or brokerage services, nor does it provide advice or recommendations on particular stocks, securities or other investments.
Investors searching for a low-risk way to fortify their retirement portfolio should consider leveraging dividend stocks as part of their investment strategy. Some use the profits made from dividend stocks to fund purchases, while others hold onto them for future use during retirement. No matter your intentions, dividend stocks can be a smart way to build wealth. Here’s what you need to know about investing in dividend stocks.
Dividend Stocks, Explained
Dividends are shares of a company’s profits that get distributed to shareholders as either stock or cash. They are paid on a specific date—often quarterly—and nearly guaranteed, which makes them solid, recurring investments.
In the U.S., most dividends are cash dividends, which are cash payments made to the investor on a per-share basis. For example, if you own 100 shares in a company and the company pays a dividend of 10 cents per share, you’d receive $10 in cash. You can also buy stock dividends, in which case you’d get a percentage increase in the number of shares owned each payment cycle.
Regardless of the type of dividend stock you buy, you get to decide what to do with the funds, including:
- Reinvesting them to buy more shares of the company
- Buying stock in a different company
- Saving the money in a retirement-friendly account
- Spending the money
Leveraging Dividends as Part of Your Portfolio
Dividend stocks are a wise way to stabilize your investment portfolio since the cash payments are likely to continue long term. Companies that commit to paying dividends usually don’t stop unless they’re in deep financial trouble.
Future and current retirees might leverage dividend stocks for added income, diversification, value, and quality across multiple sectors.
The Benefits:
The most reliable companies have track records of consistently raising their dividend payouts, meaning they’ve experienced consistent, healthy growth. This means dividend stocks can serve you even in bear markets. Allocating a portion of your portfolio to dividend stocks could help you build a time-tested portfolio that withstands market volatility.
The beauty of padding your portfolio with stocks that pay dividends is that you gain predictable (usually quarterly) payments. You could spend the cash for the payout—many retirees use this as a way to generate recurring income—but if you reinvest your returns, you can take advantage of compounding. With compounding, you’ll enjoy more profit if the stock price rises because you’ve added more shares to your stake. Plus, dividend stocks typically grow or fall with the rest of the general market, so in good times, the share price value increases in addition to the dividend payment.
A stock’s dividends are also likely to rise over time if it’s successful. Owning more shares means higher dividends and a maximized investment for you.
The Drawbacks:
Even if you reinvest your dividends, you’ll still need to pay taxes since the IRS views them as income. However, unlike fixed-income securities, bonds, or ordinary dividends, qualified dividends have lower capital gains taxes. To count as qualified, a dividend must be issued by a U.S. company or a foreign company that trades with the U.S. It also has to be a long-term hold.
The actual parameters for what constitutes a long-term hold are a bit tricky, but you’ll likely get taxed on the qualified rate if you’ve held the stock for a few months. To ensure you get the best returns on your investments, it’s best to have a financial advisor guide you through a profitable buy, hold, and reinvestment strategy. You can also keep the dividend-paying investments in tax-free retirement accounts like IRAs to avoid a big tax event.
While dividend stocks are often a safer investment for recurring returns, these returns can stop or decrease at any time, depending on the company’s performance. In times of economic slowdown, companies may choose to suspend regular dividends or retain earnings to fund new growth opportunities instead of returning profits to investors.
Tips for Adding Dividend Stocks to Your Retirement Portfolio
If you want to supplement your portfolio with dividend stocks, here are some things to consider to ensure you gain the most from your investments.
1. Study the Company’s Performance History
As with any investment, research is key. Leave the gut decisions to those with a higher tolerance for risk. If saving for retirement is your goal, take time to identify financially stable companies with solid credit ratings and a history of increasing dividends over time. Beware of companies that advertise significantly higher yields than their peers, as that could indicate trouble. Instead, study their dividend history, balance sheet, and standing within the industry compared to competitors.
2. Consider Preferred Dividends
While no dividends are guaranteed, preferred dividends take precedence over common shares. If you hold preferred stock, you have a higher claim on the company assets than others. Not only do these investments usually carry a higher rate, they’re also more of a “sure thing” should a company be forced to cut its dividends. Preferred dividend holders will get paid before common stockholders, which is good news for you if a company finds itself in financial trouble and cannot pay its shareholders.
3. Diversify Your Portfolio
You assume risk with any investment, and one way to help minimize risk is to avoid putting all your dividend “eggs” in one retirement basket—no matter how safe the environment. Your risk tolerance, investing time frame, and income needs will determine the portfolio percentage to allocate to a dividend strategy. Most experts will recommend diversifying dividend income across companies and market sectors to avoid a sudden sink if the market plummets.
Search for companies with modest payout ratios over those that promise high returns. This will help provide you with a buffer while company profits ebb and flow with the market. Then, work with a professional to amass a healthy mix of dividends (like funds and ETFs with high dividend yields) plus other investments like bonds and commodities.
4. Consult an Investment Professional
Building a well-rounded retirement portfolio is not something you should do on your own. If you’re unsure of which companies make suitable investments, have a financial advisor or investment professional help point you in the right direction. Several financial email newsletters offer advice on current market conditions and profitable stock picks that are worth your attention. In general, you want to look for companies with good performance track records and reasonable yield payouts.
Bottom Line
Dividend stocks are popular among retirees or risk-averse investors who want to engage in long-term investment strategies. Enlist the help of a financial professional to help you add dividend stocks to your portfolio. A dividend strategy can reduce volatility and generate consistent returns so you can ease into retirement with as little stress as possible.