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Portfolio > Economy & Markets > Stocks

Dividend stocks for retirement income

By Ed McCarthy, CFP, RICP

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Given a choice, most of your retirement income planning clients—the rational ones, at least—prefer less portfolio volatility to more. It’s a lot easier to sleep soundly when you’re earning steady, predictable returns, even if those returns are less than you might see from more volatile investments.

Earning decent returns in today’s low-rate environment is a challenge, though. Fixed-income products such as certificates of deposit and high-quality bonds just don’t pay very much. If your clients are wealthy, they might be able to keep up with inflation and get by on today’s rates without being forced to spend principal more quickly than they’d like to. For most clients, though, there’s a strong, long-term case that they need equity investments in their portfolio to preserve purchasing power and wealth.

But which stocks should they hold, assuming that they want both income and less volatility than the overall market? A recent paper, “Value of Dividends,” from Al Frank Asset Management (AFAM) in Aliso Viejo, California, makes the case for dividend-paying stocks. Here are some of the paper’s key points:

Dividend yields are at relatively high levels compared to 10-year Treasurys. As of late-May, the S&P 500 had a 1.97 percent dividend yield versus 2.5 percent for the 10-year.

Companies are raising their dividends. In 2012, 348 of the S&P 500 stocks initiated or raised their dividend; 381 did the same in 2013. Those increases mean higher income for shareholders.

Dividends matter for total return. From 1927 through 2012, dividends accounted for 42 percent of the total return for large-cap stocks, 36 percent for mid-caps and 31 percent for small-caps.

Lower volatility with higher returns over the long-term. Since 1927 dividend stocks have outperformed non-dividend stocks and their returns were less volatile.

Income, growth and reduced volatility—that’s a good fit for many retirees’ equity allocations. Of course, these results aren’t guaranteed and a bear market will drag down dividend stocks with all the rest. The key—and as an advisor your perspective on this is invaluable—is to prevent clients from getting rattled with short-term gyrations and selling out at the wrong time.

The stock market over time has historically had far more winning months than losing months, says John Buckingham, AFAM’s chief investment officer. “The key, as I always say is, to success in stocks is not to get scared out of them. And, so, having a dividend payment and having an income stream from what we would argue are quality companies that are not expensively valued can really help you sleep better at night.”

One potential counterargument is that we’re likely to see interest rates increase in the near- to midterm: Isn’t that bad for stocks? AFAM’s research shows that although stocks have generally done better in declining rate environments, if rates are rising because the economy is growing, that’s good news for corporate profits and ultimately dividends. 

“If you plot out the growth of corporate profits and the dips that the market has taken, it often coincides with dips in profits,” Buckingham notes. “And, so, we want a stronger economy, we want corporate profits to continue to grow and we don’t view that as a bad thing even if it comes with higher rates.”

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