Younger investors generally seek growth from their stocks, and for good reason. Though more volatile, growing companies generally deliver greater returns than the alternative. They're worth the swings and volatility shareholders must suffer, and younger investors have time to recover from setbacks anyway.
That's not exactly the case for older, retired investors, however. While some retirees may have some room in their portfolios for risk-laden growth names, as a whole, most people looking to live off their savings and investments will want to overweight their holdings with less volatile dividend stocks.
Here are four specific reasons why owning income-producing picks makes more sense in retirement.
1. You need income
It's obvious, although worth mentioning all the same -- retirees no longer earning an income by working must earn one by putting their investments to work instead. The average monthly Social Security check as of the beginning of this year was just a hair above $1,500, according to numbers from the AARP. That's not going to cut it as the sole source of income for most people. Even those ex-workers cashing the very biggest Social Security checks are only pocketing around $3,000 per month. That's certainly not bad, but it still may not be enough to cover all the healthcare-related costs that seem to materialize as we get older.
Moreover, monthly income needs to be at least somewhat predictable. Although most dividend-paying companies only offer quarterly payouts, the total amount of collected payments from a portfolio of dividend stocks is pretty steady over three-month stretches.
2. You need income growth
Some dividend-oriented companies do it better than others, while a few do it exceedingly well -- that is, increase their dividend payments over time, at least in step with inflation.
The average inflation rate varies from one year to the next, though over the long haul it gravitates to a range of between 2% and 3%. Some of the expenses that consume a disproportionate portion of retirees' income and savings, however, aren't terribly well-tempered. For instance, healthcare costs grew 5.7% in 2018 and 2019, according to PwC's Health Research Institute, which expects medical costs to rise another 6% this year.
Among the top income-producing picks to outpace inflation are so-called Dividend Aristocrats like Clorox (CLX -3.57%) and Walmart (WMT -1.93%) ... companies that have raised their dividends for at least 25 consecutive years. Better still are the Dividend Kings, which boast more than 50 straight years of per-share dividend payout growth. Familiar names from this group include Johnson & Johnson (JNJ -0.71%) and Colgate-Palmolive Co. (CL -2.12%).
3. You need less volatile, more predictable principal
The income component aside, investors without time to wait out the big sell-offs generally led by growth stocks will find dividend payers tend to suffer less when things get hairy for the broad market.
That doesn't mean dividend stocks are entirely immune to marketwide headwinds. They can stumble too. But, given enough time, their dividends and lack of steep losses actually translate into superior returns. Mutual fund company Nuveen recently published research indicating that dividend payers actually outperform non-dividend payers as a general rule. Specifically, between 1972 and the end of last year, stocks with consistently growing dividends have returned around 10% per year, while stocks that don't pay dividends (which is the case with most growth stocks) have only returned about 3%. Go figure.
Perhaps the most compelling quality of dividend stocks during tough times is the idea that investors are more likely to stick with them rather than be shaken out of them at the wrong time. Owners buy into these stocks understanding that the income they're meant to drive usually continues despite a rocky environment.
4. You may enjoy tax-advantaged income
Finally, not every investor realizes it, but certain types of dividends are once again being given favorable tax treatment.
For the very biggest earners, it doesn't help much. For workers reporting less than $39,375 worth of taxable income per year, though, qualified dividends aren't taxed at all. Above $39,376 all the way up to $434,550, qualified dividends are only taxed at a 15% rate. Taxable income of $434,551 per year or more translates into a tax bill of 20% on qualified dividends. That's a lot less than people pay on taxable ordinary or earned income -- almost half as much, in some cases.
Do note that these tax breaks only matter for qualified dividends, and don't apply to ordinary dividends, which are still taxed at earned income tax rates. With some careful planning, though, investors can make sure their dividend payers are issuing regular qualified dividend checks. Also, note that the distinction between the two types of payout is usually indicated on tax documents delivered by your bank or broker at the beginning of every year.