As you approach your intended retirement date, there's one looming question for you to answer: How the heck can I stretch my savings to last for the rest of my days? It's a common worry among Americans, both before and during retirement. A study by the American Institute of CPAs found that 30% of CPAs cited running out of money as the primary financial concern for their clients.
With a limited supply of savings, your financial needs in retirement are twofold. You want to participate in market growth, but you don't want to expose yourself to loss either. That means you need an investment strategy more aggressive than cash and low-yield bonds, but less aggressive than volatile growth stocks. The good news is, you can find that middle ground, and dividend-paying stocks may be right in the center of it. Here are four reasons why investing in dividend-paying stocks is a solid strategy for retirees.
1. Dividend-payers produce income
Dividend-payers produce income, often at yields higher than you can earn with other income-producing investments. The current dividend yield of the S&P 500 index is about 1.9%. If you look only at Dividend Aristocrats -- which are dividend-paying companies in the S&P 500 that have increased their per-share dividend for at least 25 consecutive years -- the average yield is even better at 2.4%. Those returns look pretty strong compared to the measly 0.56% you can earn on 10-year Treasury bonds.
Dividend income is useful to you directly, because it's cash flow that can pay the bills. But there's an indirect benefit, too. When your portfolio generates cash, you'll pull from that cash first to fund retirement withdrawals. That essentially reduces your reliance on selling assets. Liquidating often increases the chances you'll have to absorb losses due to timing. It also depletes your principal and reduces your future growth potential.
2. Dividend-payers give you two ways to profit
Dividend-paying stocks throw off cash, but they also grow in value. The combination of income and growth produces returns for you in all market cycles. When share prices are rising, your dividend stocks should rise in value too. And when the market inevitably goes sideways and share prices are falling, your established dividend payers should keep sending you those quarterly cash windfalls. That "rain or shine" income stream is great for your budget, but it can also keep you levelheaded when market conditions are turbulent.
There is the chance that a dividend-paying company will reduce its dividend, but that doesn't happen all that often among established dividend payers. In the first half of 2020, one of the worst economic climates on record, 56 S&P 500 companies cut their dividend, while 74 S&P 500 companies raised their dividend over the same time period.
3. Dividend-payers are stable
A shareholder dividend is a massive cash commitment for an organization. Leadership teams accept that cash commitment to make their stock more attractive to investors -- and that strategy works. But not every public company can pull it off. Funding an ongoing shareholder dividend requires disciplined leadership, predictable cash flows, and a healthy balance sheet. Those same qualities are also the trademarks of a stable organization.
Stable, established companies are ideal investments for retirees because they're lower-risk. You aren't going to see explosive growth from your dividend-paying stocks, but they're not going to fall as hard in bear markets or recessions, either.
4. Dividend-payers can hedge against inflation
Remember those Dividend Aristocrats? Those are the premium dividend payers with a 25-year-plus history of raising their dividend each year. McDonald's (MCD 0.62%) has raised its dividend annually since 1976, Chevron (CVX -0.49%) since 1993, and Proctor and Gamble (PG 0.29%) since 1956. There are 63 more Aristocrats that generate passive income that's likely to continue growing over time.
Given that you'll hopefully be retired for 25 or 30 years, inflation will erode the purchasing power of your wealth over time. The only way to combat that is to increase your income -- and that's exactly what a Dividend Aristocrat can do for you.
Stretch your savings
Dividend-paying stocks throw off passive income at higher yields than what you'd get from cash or Treasury bonds, and they'll show stable value growth at the same time. The most established dividend-paying companies will also increase their dividends annually, which is a nice defense against inflation. That set of perks won't guarantee solvency for the rest of your days, but it will help you stretch your savings without absorbing too much risk.