If you want to create an income stream of, say, 4% of your retirement savings, can't you simply put your money into high-yielding stocks and let them do the work? This certainly is an option, but it isn't without its risks. In this Fool Live video clip, recorded on Nov. 3, Fool.com contributor Matt Frankel, CFP®, discusses what investors should know before setting up a dividend-income portfolio in retirement.
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Matt Frankel: Mike G has a really good question, and I love this one. "If I were to need 4% of portfolio withdrawn per year," that's the 4% rule that we talk about pretty often in Fool articles, "why isn't it better to have a 100% stock portion of dividend stocks that would get me 4%, versus having a diversified allocation of which I will have to sell stocks to get the money? Is the problem just finding stocks paying 4% or more?" It's true that it's tougher than it used to be to find stocks that pay 4% or more.
I'm sure Bro remembers in the '90s, dividend stocks generally paid a lot more than they do today. But that's not the issue. Let's say that you have a portfolio of real estate investment trusts, which are my favorite type of stocks, and it's not that tough to find a portfolio of REITs that pay in the 4% ballpark. The problem is, those dividend payments are not guaranteed. That's the big problem. During COVID, for example, about half of the REITs I follow either suspended or slashed their dividends. The same thing happened during the financial crisis. It's not just the COVID pandemic. During the financial crisis, a lot of REITs had to cut their dividends.
That's the big risks with that, and you're also tying your money to one general asset class. If interest rates rise, for example, dividend stocks tend to be very sensitive to that. If let's say rates spiked, they double in the next year or so: A portfolio of just high dividend stocks is likely to be very under pressure when it comes to the value of those stocks. It's always a good idea to keep some sort of diversification going on. Most of the high dividend stocks, you said 4% or more, most stocks that pay that are either in real estate or utilities, right now or telecom.
It's really tough to create a diversified portfolio that pays 4% dividends. Someday, it might be easy again, like it was in the '90s do that. But again, those payments are not guaranteed. That's really the caveat to that method. I'm generally a fan of the 4% rule. But the dividend income strategy, there are some things to keep in mind with that.