Are qualified dividend paying stocks a reliable source of passive income for retirement?
After exhausting all forms of saving for retirement, would adding stocks that pay qualified dividends be a better and less expensive way to earn passive income than paying expense ratios and other fees? The tax rate for some might be lower than drawing from retirement accounts.
Not only are taxes lower on dividends then an IRA withdraw, but think of it this way; if you take regular distributions from a mutual fund within your IRA, what happens if the market declines? You would be liquidating shares of your mutual funds to meet your distribution requirements. This depreciation accelerates the lower and longer the market declines. When the market does recover, your account will be worth less than what you started with because you have fewer shares.
On the other hand, if you have a portfolio of solid dividend stocks, you can live off your dividends and not sell any shares of stock even during a market downturn. When the market recovers, your portfolio should too.
Even though you lose the tax advantage, I recommend using dividend stocks in your IRA as well and match your distributions to the portfolio's dividend yield.
If I understand the question, you are asking if funneling your savings into dividend stocks is preferable to saving in a retirement fund. I would divide your question into two parts. The first part is the question of dividend stocks versus a fund of dividend stocks. To this question, I would always prefer a low cost, low-turnover fund of dividend paying stocks. Unless you can buy a large number of stocks, the diversification of a fund will smooth out the ups and downs, and will avoid concentration in some big duds. Remember Polaroid, Xerox, TWA, Sears? They all paid dividends.
The second part of the question is, should this savings be inside a retirement account or outside? The answer really depends on your current tax rate and your estimated future tax rate. If you think your tax rate will decline in the future, and you can make a tax advantaged contribution today (Roth, deductible IRA/401(k)), then I'd go the retirement account route. Time is also a factor. If your deferral period is short, it may not be worth it, but for most people, it is over 10 years, making the retirement account more attractive.
There are some less tangible benefits to having your stocks or funds within an IRA that are hard to pin a value to. The foremost of these is that when you own a stock or fund in an IRA, you are more likely to trade out of the loser, you are more likely to sell and adjust to market changes and manager changes. You are less likely to still be holding some star fund long after the manager left and the performance tanked. If someone is a frequent trader, this could be a negative, but most investors I see suffer from extreme inertia. The second advantage is that in a retirement plan, you are more likely to mentally "lock it away" and not spend it. Again, it depends on the individual's tendencies as to whether this is a factor.
I'm not sure if it would be better, but it may well be less expensive. Understanding this correctly is important. Dividends, interest, and capital gains are actually tax free for those individuals who can maintain a 10% or 15% federal income tax bracket. This is a very unusual provision and I've seen clients taking advantage of this on an ongoing basis who do not have substantial taxable income. In addition, I would ask you to take into consideration that the stock market is higher than it's ever been in the past. That being the case, there are always good companies to invest in and those that pay dividends are doing so in lieu of adding funds back to their own capital structure for future use. There are many companies that have increased dividends continuously over the years and you might want to look at these and then try to get some professional advice. Be careful not to buy high levels of income just because they're high. A very high dividend may indicate a poor investment opportunity that others see by driving the price of the stock down and the yield up. Hope this helps and good luck!
No! The additional risk associated with individual stocks positions is not worth the dividends they pay. The total return of an investment is a product of both cash flow (dividends) and the price. High-yielding dividend paying stocks are another way of getting exposure to “value-stocks” which are generally riskier companies. You may receive consistent dividends, but the price of stock can fluctuate quite a bit affecting the overall value of your retirement savings.
Companies that do not pay dividends are reinvesting their profits into the future growth of the business. As a stockholder, you have a stake in the future profits of the company.
A better way to invest is to buy and hold a globally diversified portfolio of index funds. If you need cash flow, you can sell some of your mutual funds at a minimal cost versus taking risk in individual stocks positions.
This is a question we get often from retirees, and there are several ways to look at it. The short answer is yes, a well-diversified portfolio of higher-quality dividend paying stocks has historically been able to generate reasonable amounts of income over time. We would generally advise utilizing a number of low-cost dividend index funds that will help you diversify your assets. There are some low-cost funds that pay monthly dividends instead of quarterly to help provide an even more consistent income stream. However, we generally recommend a diversified portfolio of stocks, bonds, and money markets, and draw a reasonable amount from that portfolio over time, usually no more than 4% of your total portfolio’s value. It’s best to work with a professional advisor to find an appropriate asset allocation and withdrawal an amount that will work for you.