If dividend stocks aren't a central piece of your retirement investment portfolio, it's time to think about adjusting your strategy. Dividend stocks can't be the only investment in your portfolio, but they still bring a number of valuable features. You can't get that exact combination of attributes anywhere else. Keep these four reasons in mind when you set up an investment plan in retirement.
1. Dividend stocks produce income
Income is the single most important piece of your financial plan in retirement. Obviously, you no longer receive cash flows from wages and salaries when you stop working. You'll need to find other sources of cash to pay for food, medical expenses, household items, clothing, and travel -- anything you need or want to consume. Social Security benefits are helpful, but they aren't enough for most households to maintain their lifestyle.
Dividend stocks are a great source of income for retirees. Companies that produce reliable profits and have enough cash in their bank accounts choose to distribute those profits to shareholders on a quarterly or monthly basis.
Unlike other types of equities, dividend stocks still perform even when market crashes pull their price down. They cut investors a regular check, regardless of share prices. This allows shareholders to avoid selling during bear markets.
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2. They often reduce volatility
Retirees also need to be careful with volatility. Stocks naturally rise and fall in value over time. For the market as a whole, crashes have only been temporary disruptions from a long-term upward trend. Unfortunately, retirees might need to convert investments into cash in the short term. They don't have time to wait for a market recovery, and volatility is a much bigger threat.
Dividend stocks still rise and fall like the rest of the market, but they can help reduce overall volatility in your investment portfolio. When economic conditions turn bad and people start selling stocks, established, reliable companies often become more popular. Their predictable dividends can help keep their prices from falling too much.
Consider the Invesco S&P 500 Low Volatility ETF (NYSEMKT: SPLV), which is designed to provide equity-style growth without experiencing as much price fluctuation. Mature, dividend-paying companies such as consumer staples and utility stocks make up a significant portion of the portfolio. Tech and consumer cyclical stocks are a much smaller piece of the allocation.
3. They're a better inflation hedge than bonds
Inflation eats away at the buying power of a dollar each year. That can be bad news for retirees who are living off the interest payments from savings accounts and bonds. Every year, those investments produce the same amount of cash, but that cash buys a little bit less.
Stocks are often used to combat that effect. Stock prices generally rise with inflation as everything in the economy gets more expensive. The dividends paid by those stocks generally grow as well. You might not outpace inflation, but you'll be in better shape to keep up with it.
We are seeing this play out right now. Inflation is reaching its highest level in years, and stock indexes are riding aggressive valuations to record levels. The market reacts negatively to any indication that the Fed might combat inflation by raising interest rates. Dividend stocks are currently keeping pace with rising prices better than bonds are.
4. They pay higher yields than Treasuries right now
Dividend stocks can also produce more income than certain popular bond types. U.S. Treasuries are often considered "risk-free." As a result, investors hold them without expecting high yields. You can usually get a much higher yield from a diversified dividend portfolio.
Ten-year Treasuries are paying 1.3% interest rates. The average dividend yield of the S&P 500 is actually higher than that, and many dividend stocks have still higher yields.
There are other types of bonds, of course. Investment-grade corporate bonds deliver better rates than Treasuries without a ton of risk. However, corporate bonds that aren't considered high risk currently have yields that are fairly comparable to many reliable dividend stocks. Those bonds certainly don't possess the combination of features discussed above.
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