When to Add Dividend Stocks to Your Portfolio -- and How to Pick Them

Dividend stocks are perfect for retirees, but that doesn't mean you should wait until you retire to buy some.

Wendy Connick
Wendy Connick
Jun 29, 2017 at 9:22AM
Investment Planning

Early on, a good retirement savings plan focuses on growth. The faster your nest egg can grow, the bigger it will be by the time you need to use that money. And while investing for growth is a bit risky, the fact that your retirement savings will be sitting there for decades means high volatility isn't a huge problem; you have plenty of time to recover from the market's swoons.

However, once you get closer to retirement, it's time to start prioritizing income, rather than growth, and dividends paid by publicly traded companies can diversify a retiree's income streams. While dividends are not guaranteed the way that bond interest payments are, companies that churn out large dividends over long periods of time are likely to continue doing so, barring some internal disaster. As a bonus, the kinds of companies that issue large dividends are typically large, stable companies that carry lower risk in general than young, small, high-growth companies. And as you get closer to retirement, any approach that lowers your risk is definitely a big plus.

now or later?

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When to start your transition

In your 20s and 30s, growth should definitely be the top priority. Once you hit your 40s, though, it's a good time to start looking for bargains on great dividend stocks. As you pass through your 40s, you can gradually increase your holdings of high-dividend stocks and cut back on the riskier, more volatile growth investments. By the time you hit 50, around half your growth stocks should have been replaced by more stable dividend-payers.

By the time you hit 60, you'll have parted ways with your volatile growth stocks. This approach gives you plenty of time to browse for deals on great dividend stocks, instead of having to snap up a bunch of them all at once, regardless of value. It also means you'll enter your 60s with a far more stable and less volatile portfolio, which is extremely important as you approach retirement.

Choosing individual dividend stocks

If you prefer to pick your own stocks, rather than go with a high-dividend mutual fund or ETF, you'll want to look for companies that epitomize stability and believe in passing profits on to their shareholders. After all, this is a stock that you will (hopefully) hold for decades.

One criterion for dividend stocks is a high dividend yield (the stock's price divided by the dividend it paid out per share over the last year). A "high" dividend yield is open to interpretation, but you certainly want stocks that do better than the S&P 500 average of 2%.

You should also look for stocks with a good payout ratio. The payout ratio is the percentage of earnings that a company has spent on dividends over the last year, and it serves as a gauge of the dividend's sustainability. If the payout ratio is over 100%, then the company is paying out more than it's bringing in, which means it will eventually be forced to cut or suspend its dividend. A payout ratio well under 100%, on the other hand, indicates that the company can easily keep up its current dividend yield and will likely increase it.

A company's dividend history can also provide clues about what the stock will pay out in the future; companies that have paid high dividends for decades on end and regularly increased their dividends are likely to continue doing so. A company that has raised its dividend at least 25 years in a row is classed as a "dividend aristocrat" and could be a superb choice for your portfolio.

Certain types of stocks lend themselves particularly well to retiree portfolios. Utilities are a popular choice, as they are essential service-providers that usually have the significant benefit of being monopolies. That combination makes them an extremely dependable source of dividends. Blue-chip stocks are another good choice for retirees, but before investing, you should check the company's record to make sure it has paid dividends religiously over the long term. And remember to keep an eye out for bargain-basement share prices on stocks that qualify. Then you might be lucky enough to score great dividends and impressive capital gains.

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