May 6, 2009

Living with Dividend Cuts

It's been a tough stretch for investors who rely heavily on dividends for their retirement income.

GE recently cut its dividend for the first time in over 70 years; Dow Chemical reduced its payout for the first time since 1912. Dividends (and stocks) from financial-services companies are projected to fall by 25 percent in 2009, and while some industries like consumer staples are maintaining their payouts, it continues to be a difficult market for dividend seekers.

Prior to this bear market, the case for retirees to consider investing in dividend-paying stocks was strong. Many companies had long histories of increasing their dividends over time, providing a hedge against inflation. It wasn't just about the income, though: The stocks' potential for capital gains was another proven benefit, at least under normal market circumstances.

How should an adviser help clients replace income that's been lost to dividend cuts? Jim Weil, CFP, with Financial Strategy Network LLC in Chicago describes the process as a balancing act that involves the juggling of four factors.

"The first factor is trying to generate enough cash flow to live on," Weil says. "The second is trying to protect the down side. The down side could be your capital base or your continued income stream from the dividends and the interest. The third is still allowing for some room for appreciation, because though we're not yet out of the woods from our current economic crisis, there will be better days ahead; and we still need to have our clients positioned so they'll benefit from that. And then the fourth point would is anticipating some future inflation as a result of all these different spending programs by the government."

Jamie Cox, managing partner with Harris Financial Group in Colonial Heights, Va., says that one of the by-products of the decline in the market over the past eight months, particularly with the demise of Lehman Brothers, has been the opportunity to buy fixed-income assets.

"Instead of owning the stock of a utility, own its bond, because while a board of directors can decide whether or not to alter a dividend, it can't decide to alter an interest payment," Cox notes. "So you are able to get the dividend or the interest payment from the bond, and yet the bond prices were reduced to almost the same levels as the underlying equity. You are able to get a pretty deep discount and probably a higher net effective yield by using the corporate bond, as opposed to the equity."

John Sullivan, CFP, with World Equity Group in Arlington Heights, Ill., has also been recommending alternatives to dividends. He notes that investors need at least 20 individual stocks for adequate diversification, so his firm has been seeking and finding deals among depressed short-maturity bonds.

"We've bought some good high grade corporate bonds because hedge funds have so many liquidations," Cox says. "We were able to pick up some A or above corporates that were paying 6.9 percent that were three-year (maturities), so that's great."

Reprints Discuss this story
This is where the comments go.