If you want a traditional retirement -- one that doesn't involve a part-time gig driving for Uber or sharing an address with your kids -- you need passive income. There are various ways to generate passive income as a retiree, but investing in dividend-paying stocks might be the simplest and most reliable approach. Here are three reasons why dividend payers are a great fit for your retirement portfolio.
1. You don't have to sell to raise cash
Dividend-paying stocks replenish your cash stores throughout the year. In a perfect world, that quarterly influx of cash would be enough to cover all of your living expenses in retirement. But even if your dividends only cover 10% of your income needs, that's 10% you won't have to raise by selling positions.
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It's to your benefit to limit your liquidations when you can. Each sale of a stock or fixed income position reduces your earnings power going forward. It also exposes you to timing mistakes, such as selling something the day before a market rally. To be clear, that's not going to make or break your finances. If you're liquidating regularly, the timing can work in your favor as often as it works against you. But it is human nature to react more to negative outcomes than positive ones. In other words, one timing mistake can feel pretty awful in the moment. Worse, it might lure you into trying to time your liquidations strategically -- and that strategy often backfires.
2. Rising dividends hedge against inflation
Inflation is constantly at work undermining the value of your money. You may not notice it as much before retirement, because you're getting annual raises that offset your rising living expenses. But in retirement, your "raises" consist of cost-of-living adjustments on Social Security and the voluntary increases you make to your retirement distributions.
The right dividend-paying stocks can add another type of raise to the mix. Premium dividend payers, such as Walmart, Coca-Cola, Proctor & Gamble, Target, Clorox, McDonald's, and T. Rowe Price Group, have a reputation for increasing their dividends each and every year. Walmart, for example, has been raising its dividend for 50 years straight. The upticks aren't enormous -- in 2020, the mass retailer increased its quarterly dividend from $0.53 to $0.54. But when you're retired, every penny counts.
To find dividend payers that are likely to raise their dividends annually, look to the Dividend Aristocrat Index. Companies earn Dividend Aristocrat status by, among other things, increasing their shareholder payout for at least the last 25 consecutive years.
3. Dividend yields are higher than bond yields
Fixed income has long been a core piece of the traditional retiree portfolio, because it provides both income and capital preservation. Unfortunately, in the current era of ultra-low interest rates, high-quality bonds aren't as appealing as they once were. In March of this year, the 10-year Treasury yield hit an all-time low of 0.318%. It's recovered slightly since, but still sits below 1% as of mid-October. That's about what you can earn in a high-yield savings account. More importantly, it's less than what you can earn with dividends. Dividend yields for Walmart, Proctor & Gamble, and Coca-Cola, for example, are 1.49%, 2.19%, and 3.29%, respectively.
That's not to say Treasury bonds don't have a place in your portfolio. They are still safer and have less short-term volatility than dividend-paying stocks. Bond yields will also probably remain low for the next few years, but they're likely to tick back up eventually. For those reasons, it's wise to lean on dividend payers for higher income, while remaining diversified in fixed income positions, too.
Dividend-payers for cash flow in retirement
Choose the right dividend-paying stocks and you should have an ever-increasing source of cash to help fund your retirement distributions. Plus, some of the most mature and stable dividend payers, like Walmart, produce higher yields than what you can earn on Treasuries in the current interest rate environment. Those are attractive qualities for a retiree, especially if the extra income means you won't have to spend all of your spare time driving strangers around for Uber.
