Going from work to retirement is one of life's biggest transitions, right up there with marriage, births, divorce, and colonoscopies. So you'd think that your portfolio would get an overhaul as it moves from "feed me!" (accumulation) to "feed you" (disbursement). But that's not necessarily the case.
Sure, you certainly should review your portfolio when you retire, but that's something you do at least once a year anyhow. And, if you're like the typical investor, you've gradually become more conservative with your investments as you near retirement, so you should already have some fixed-income investments as well as a pile of cash.
But you shouldn't get too conservative; you'll still need a healthy dose of stocks to ensure that your portfolio keeps pace with inflation.
Thankfully, for simplicity's sake, your portfolio shouldn't require an extreme makeover as you age. That's because -- regardless of your stage in life -- your asset allocation plan should be dominated by dividend-paying, blue-chip stocks.
A bird in the hand ...
First, let's start with why you want dividends. Let's say you sorted the Standard & Poor's 500 according to dividend yield, and then invested $1,000 in the 100 highest-yielding stocks and $1,000 in the 100 lowest-yielding stocks. A year later, you re-adjusted your portfolio so that you continue to hold only the 100 highest-yielding and the 100 lowest-yielding S&P 500 members. What would your returns look like a few decades down the line?
If the future looks anything like the past, the portfolio with the higher dividend yield will crush the lower-yielding portfolio. That's what Wharton Business School professor Jeremy Siegel found when he conducted just such a study for his book, The Future for Investors. From 1957 to 2003, the lower-yielding portfolio returned an average 9.5% a year, turning that $1,000 into $64,930. However, the higher-yielding portfolio returned a compound annual average of 14.3%, growing $1,000 into $462,750. Astounding! (In case you're curious, the S&P 500 itself returned 11.18% annually in that same time period.)
The lesson is that dividends matter -- a lot. Besides better returns (as if there's anything else that matters), dividends have other benefits. They're the proverbial bird in the hand. They represent cold, hard cash -- not capital appreciation that can disappear in the next bear market (and there will always be another bear market). Qualified dividends also are taxed at no higher a rate than 15%, which is lower than ordinary income and short-term capital gains (assuming you follow the rules and hold the dividend-paying stocks outside of your retirement accounts).
Finally, when you retire, stop reinvesting the dividends and instead direct your brokerage to send you a check to help fund your lifestyle. It's an option that only dividend-payers can offer, and that's why I've called them the right stocks for retirement.
Companies that will last
Of course, that strategy will only work if the companies in which you invest will be around for a few decades. And this is where blue chips come in. Investopedia.com defines blue-chip stock as "stock of a well-established and financially sound company that has demonstrated its ability to pay dividends in both good and bad times." If that isn't the type of company you want to build your retirement on, I don't know what is.
So, where do you find such companies? Start by looking for those that have been around a long time and have a history of increasing their dividends. For example, the following companies have increased their dividends for at least 10 years in a row and sport above-average yields:
|
Company |
Yield |
|---|---|
|
Bank of America (NYSE:BAC) |
4.2% |
|
General Electric (NYSE:GE) |
3.0% |
|
AT&T (NYSE:T) |
4.8% |
|
Coca-Cola (NYSE:KO) |
2.9% |
|
Consolidated Edison (NYSE:ED) |
5.2% |
|
Pitney Bowes (NYSE:PBI) |
3.1% |
Once you've compiled a list of possibilities, dig in for further research to determine if the stocks fit your timeline and risk tolerance. Or check out The Motley Fool's latest special report: 10 Monster Stocks to Anchor Your Portfolio. The report details 10 companies and two bonus mutual funds that can serve as a strong foundation for any portfolio. Even better, the report is yours free with a subscription to our Rule Your Retirement planning service.
The Foolish bottom line
Regardless of where you are along the road to retirement, a foundation of cash-producing blue chips is something on which to build a portfolio that will provide growth and income for decades. And that should help you retire happy.
Click here for a no-obligation 30-day free trial to Robert's Rule Your Retirement newsletter, the service designed to help you take control of your financial future.
Robert Brokamp does not own any of the companies mentioned in this article, but he does eat too many chips. Bank of America and Pitney Bowes are Income Investor recommendations. Coca-Cola is an Inside Value pick. The Motley Fool has a disclosure policy.
