The Importance of Dividends for Retirees

 In Market and Investment Insights, Retirement Planning & Wealth Management

As people live longer, finding ways to sustain income throughout retirement is more important than ever. We asked Portfolio Managers Alex Crooke, Job Curtis and Ben Lofthouse to discuss the role of dividend income.

Where can investors go when seeking steady and attractive levels of income?

Given that interest rates are so low on deposit accounts, investors have to move further up the risk curve to generate income from their savings. Because equity returns are not risk-free, it’s important to diversify one’s sources of income. A portfolio that includes dividend-yielding securities can help to diversify that income. We see opportunities in diverse industries, countries and currencies.

How relevant or effective is geographical diversification given that markets have become more correlated in recent years?

Equity market correlation is an important consideration, but dividend income tends to be a lot more stable than underlying stock earnings and typically less volatile than market movements and share prices. If you are willing to buy and hold through cycles and market movements, a focus on dividends can potentially provide steady income that can grow over time. What’s important is the diversification of the income streams.

What are some reasons investors should consider including a dividend focus in a diversified portfolio?

The cost of living is rising in many crucial areas. This includes health care, education and rent. People are also living longer on average. A thoughtful approach to equity income investing can help address these challenges because the income and capital have the potential to grow over time.

Is this a particularly good time for dividend-focused investing?

While dividend yields are in line with history, interest rates are very low around the world. In our opinion, it’s not an exceptional time for dividends, but rather an exceptionally difficult time to live off income from bonds and cash alone.

What are some of the major risks and opportunities associated with dividend investing today?

First, in equity investing there’s the risk of capital loss. Therefore, investors need to have a longer-term investment horizon. Over-concentration is another key risk. You want to avoid concentration in any one stock or industry because market conditions can change.

Stretching for yield can also be dangerous. Simply buying the highest- yielding stocks can be a recipe for disaster as the market could be telling you a cut is likely, and in that event you might lose income and capital. An analysis done by Bernstein Research examined the top 1,500 stocks by market capitalization and returns, grouping them based on dividend yields. It found that robust total returns came from a middle grouping of the second and third quartiles, rather than the lowest- or the highest-yielding groups.

Now, you wouldn’t want to base an investment decision on returns alone. You’d want to do more research to understand the company as well as your investment objectives and tolerance for risk.

What do you believe are the benefits of investing in dividend-paying stocks versus either bonds or non-dividend-paying stocks?

For investors with the appropriate risk tolerance, the main advantage dividend-yielding stocks have over bonds is the potential for both income growth and long-term capital growth.

Because a bond’s income is based on the stated coupon rate, its income will likely stay the same, unlike stock dividends.

As far as non-dividend-paying stocks, they don’t provide income. So if you want to live off them, you’d have to sell some shares to take money out. Of course, income is only one consideration in selecting an investment. It’s also important to evaluate the company as a whole and make sure the selection is appropriate for your financial goals and risk tolerance.

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Foreign securities are subject to additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all of which are magnified in emerging markets.

Diversification neither assures a profit nor eliminates the risk of experiencing investment losses.

Correlation measures the degree to which two variables move in relation to each other. A value of 1.0 implies movement in parallel, -1.0 implies movement in opposite directions, and 0.0 implies no relationship.