Here are the risks of using dividend investing in your retirement strategy
Dividend investing, a strategy in which people target stocks with quarterly payouts, may provide relief in retirement.
At a time when the surplus that pays out Social Security benefits is estimated to be depleted by 2031, leaving beneficiaries with about three-quarters of their full benefits, pre-retirees may turn to stocks and dividends as a way to bridge their retirement income gap.
Financial experts offer Cashay readers the risks to dividend investing that should be considered.
Is it enough?
While dividend investing can supplement Social Security, it depends on the amount you have invested.
“The S&P 500 dividend yield is below 2%. That means you have to have a lot of savings to live only off the dividends,” said Nick Holeman, CFP, head of financial planning at Betterment.
Falling revenue at a company also plays a role in how much investors will receive from dividends, which could affect your retirement income.
“If a company is making $0.10 per share in revenue, then they cannot support paying $0.20 per share or more in dividends,” said Josh Simpson, financial adviser with Lake Advisory Group, a financial firm. “It would be realistic to expect to build a moderately conservative dividend portfolio that would yield roughly 3% to 4% annually.”
While dividend investing may entice high net worth investors with better tax benefits compared to other products, they should plan for volatile times when dividends don’t pay out as much as planned.
“Investors should plan for variability in dividend payments. Through 2008 and 2009, dividends were significantly cut, which was quite painful for retirees who relied on them to meet non-discretionary spending needs,” said Katherine Roy, chief retirement strategist at JPMorgan Asset Management. “For this reason I’d recommend aligning a dividend-oriented investing strategy to discretionary spending that can adjust should markets be challenged and dividends are potentially reduced or eliminated.”
Make sure to adjust your spending expectations as you age, too. The Federal Interagency Forum on Aging-Related Statistics, which found that those age 75 and older devoted 16% of their annual spending to health care, while for those in the 45 to 54 age range that number was 7%.
“Investing in retirement requires a careful balance of growth for the long term — lifestyle needs, healthcare costs — and income to meet current spending needs,” Roy said.
High dividend paying stocks are concentrated
While most financial experts recommend having a diversified portfolio, a dividend stock strategy won’t necessarily accommodate this.
“Focusing only on dividend-paying stocks has two major cons that make it a bad decision in Betterment’s opinion,” Holeman said. “Stocks that pay high dividends are usually concentrated in a few sectors of the economy, so your portfolio won't be as diversified as it should be.”
He recommends retirees take a “total return” approach that uses both investment income and capital gains to support your retirement needs.
“It is more diversified and more tax-efficient,” Holeman said.
Finding the ‘right type of yield’
Yield is a key factor in making your dividend investing strategy work in retirement.
“Yes; we do believe that dividend yield is a reasonable method to supplement Social Security income in retirement years, but it has to be the right type of yield,” said David Wagner, portfolio manager and analyst at Aptus Capital Advisors, a financial firm. “Given these low interest rates, investors tend to stretch for yield, and we believe that tends to bode poorly for investors as they fall into value traps.”
Focus on high growth stocks in addition to dividend yield, he said.
“There needs to be a healthy balance between both growth and yield,” Wagner said. “And we believe that there is an abundance of potential candidates that fit this mold that can provide above average yield relative to other asset classes while also allowing for future business growth.”
Dhara is a writer for Cashay and Yahoo Money. Follow her on Twitter @dsinghx.
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