Once you retire, the way you interact with your money changes. Instead of earning money through work to cover your costs and invest a bit, you rely on your investments to provide the money to cover those costs. That shift in your reality should drive a shift in your investing strategy.
Dividend-paying stocks can play a role in getting you that money, but they are not the solution all by themselves. After all, dividends are not guaranteed payments, and when a company cuts its dividend, its stock price can drop as well. Still, the benefits they provide are often worth the risks, which can provide a compelling case for retirees to own them. With that in mind, here are five reasons to invest in dividend -paying stocks in retirement.
1. They provide cash
The most obvious reason to own dividend-paying stocks in retirement is that they typically pay those dividends in the form of cold, hard cash. You could use that cash to pay your bills, replenish the maturing rungs in your bond ladder, to reinvest for your grandkids' educations, or for any other purpose you'd like. That's the beauty of cash -- once you have it, you can put it toward any purpose you'd like. It's the ultimate in financial flexibility.
2. Dividends can grow over time
The strongest dividend payers around not only deliver the cash, but they also seek to increase their payments over time as the companies behind those dividends grow. Businesses with long histories of dividend hikes are published on lists with names like "Dividend Achievers," "Dividend Champions," and "Dividend Aristocrats."
Especially in an era where rising inflation is putting the purchasing power of each dollar at risk, the potential of an increasing income stream becomes that much more attractive. Companies with a history of both paying and increasing their dividends can be a powerful source of that kind of cash flow. That makes them a powerful potential tool in a retiree's fight against long-run inflation.
3. Dividends can tell you what management really thinks
Once a company gets a reputation of paying and increasing its dividend, its leadership probably recognizes that its investors expect such raises over time. From the company's perspective, however, the big challenge with dividends is that the company has to generate that cash in order to pay it to the shareholders.
That means that a company with a fairly well established dividend is not likely to increase that dividend faster than it expects its earnings to grow. It's a classic case of "put your money where your mouth is" . If a company says great things about its prospects but only offers up a token dividend increase, there's a good chance that what it does with its dividend tells a clearer story than what it says in its press release.
4. You can use dividends as a check on the company's financial health
One particularly useful part of a company's dividend is that you can compare it to other financial measures to help you get a sense of that company's overall financial health. For instance, a company's payout ratio will tell you how much of its earnings it pays out with that dividend. If that measure is too high, you might have reason to believe the dividend may be at risk in the future.
You can also look at a company's dividend in the context of the total it pays out between dividend and interest payments. That measure can help you get a handle on what other financial obligations the company has to pay. Interest payments are always a higher priority than dividend payments . As a result, a company whose dividend looks tiny compared to its interest obligation may be at a somewhat elevated risk of a dividend cut.
That's especially true if interest rates rise in response to higher inflation . After all, if a company is forced to roll its debt to higher rate bonds as those debts mature, then its interest expense will go up. That means less of its cash flow will be available for dividends.
5. Companies' dividends don't depend on the stock market's mood
On any given day, a stock's price might finish higher or lower than it did the day before. Particularly during market crashes, even strong companies' shares can drop. Unlike its market price, however, a company's dividend is based on its operating strength, not Wall Street's day-to-day whims.
That makes dividends a potentially powerful way of accessing cash even during down markets. After all, you don't have to sell your stock to get the cash from that dividend. During a down market, that can be a particularly powerful way to get hold of money to pay your bills or to reinvest in great companies at bargain prices.
Just remember that a dividend can get cut if the company's operations suffer. So keep your eye on the fundamental and financial health of the businesses you own. Let those fundamentals determine whether it's time to buy more, hold on to what you've got, or get ready to sell and look for better opportunities.
Especially in retirement, cash is King
Once you retire and start relying on your portfolio to cover your costs, you become all that much more aware of how important it is to have cash available when you need it. Dividends can play a key role in generating that cash, and the five reasons above show why.
The best time to start getting your portfolio retirement ready is before you're ready to call it quits. That way, you're able to retire on your terms, and not just if the market happens to be cooperating. So get started now, and bring the retirement you're hoping for that much closer to reality.