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Dividend Investing for a Secure Retirement

Everyone wants to live their best worry-free retirement, which should include spoiling your grandkids, enjoying your favorite restaurants and maybe even traveling the world.   You certainly don’t want to be worrying about money.  That is where the benefit of having a retirement income plan comes in.  And that plan should provide reliable-growing income and long-term appreciation, regardless of what the markets are doing in the short run.  As a wealth management firm, we believe that Dividend-Growth investing is the best way to enjoy both a reliable, diversified, growing income stream for your life in retirement, as well as long-term appreciation offered by stocks to help protect you from inflation.  That portfolio and the income it produces can also be passed to your children in a tax-efficient manner unlike certain financial products like annuities.    For these reasons, HCM has long operated our Dividend Growth Portfolio™ which consists of about thirty individual stocks that pay and grow their dividends annually.  This brings many unique advantages to the retirement income plans we design.

How Dividend Investing Works

To receive dividends, one must first own dividend paying stocks.  Dividends are usually paid quarterly, typically as a set dollar amount per share.   For example, if company XYZ pays a quarterly dividend of $0.50 per share, an investor owning 1000 shares would receive a dividend payment of $500 four times a year.

There are several good reasons to invest in a Dividend Growth strategy. Today we’ll focus on three: capital preservation, inflation protection, and tax efficiency.  

Capital Preservation

Many people invest in the stock market to help build wealth.  Over the long-term, that has proven to be a safe bet: during the past 90 years, the average annual return of the S&P 500 has been 9.8%.  However, a third of those years investors saw the value of their stocks decline.  To enjoy the financial benefits that investing in stocks can provide, you must be able to ride out the volatility without doing long-term damage to your family’s net worth.  If you don’t have adequate income coming in during these down cycles in the market, you may be forced to sell your stocks to pay the bills.  By needing to sell shares when the market is down, you are forced to sell more shares to generate the income you require.   That means you will have fewer shares left when the market rebound arrives, preventing you from fully participating in the recovery.  This reduces your future income potential and may cause a premature exhaustion of your retirement assets.  

How does Dividend Growth Investing address this problem?  By regularly generating income from the investments you hold, you aren’t forced to sell in a down market.  This means there’s no difficult decision regarding which assets to sell and which assets to hold.   Additionally, dividend-paying stocks are historically less volatile than non-dividend-paying stocks, meaning the dips are likely to be less severe when you invest in these securities.    

Moreover, dividend investing is compatible with a long-term investment strategy, allowing you to avoid the emotional turmoil of riding every peak and trough of the market.  In a previous blog, we noted that frequent retail traders are “basically paying fees to lose money.”  By staying out of the trading game, you can let your portfolio produce income for you, preserve your principle, and enjoy long-term appreciation that will help you in retirement.

Inflation Protection

Inflation is corrosive to retirement savings, as it diminishes your purchasing power.  Although investment returns are usually quoted in percentages, you don’t pay your bills in percentages.  You pay your bills in dollars, which purchase a little less every year as inflation erodes value.  

This is where a Dividend Growth Investing strategy can be a real benefit.  Some dividend investors only care about the yield, which is great in the present, but a static yield means that the dividend loses purchasing power as a result of inflation.  Instead, HCM employs a Dividend Growth Strategy, in which we select not only stocks which pay dividends, but stocks with a history of growing those dividends.  By doing this, dividends not only keep pace with inflation, but often exceed it, leading to an income with increasing purchasing power over time.  Over the past 50 years the S&P 500’s dividends grew at an average rate of 5.7% per year, outpacing the average 4.1% inflation rate. Additionally,  from 1930 to 2017, dividends made up 42% of the S&P Index’s total return, while from 1972 to 2017 dividend payers returned 9.25% per year, far surpassing the 2.6% returned by companies that didn’t pay dividends.   The average dividend growth of the Dividend Aristocrats over the past five years is 9%, with 87.5% of the stocks providing a dividend return above the 4.1% inflation historically experienced.   

Tax Implications

Many dividend stocks qualify for preferential tax treatment that other investment vehicles don’t.  A Qualified Dividend must meet certain criteria in order to be entitled to tax-preferenced status.  Two of the guidelines pertain to the company that pays the dividend, while the third guideline has to do with how long the dividend-paying stock has been held by the taxpayer.  In order for a dividend to be considered qualified, it must be issued by a U.S. company or a qualifying foreign company, it must not be listed as a non-qualifying dividend by the IRS, and it must be held for the required holding period (the vast majority of dividends qualify for tax -preferenced treatment).   

Once those criteria are met, the dividend income is taxed at lower capital gains rates rather than being taxed as ordinary income.  Notice that if you can properly design your income through tax planning, a significant amount of dividends can be received tax free.   Dividend (and long-term capital gain) taxes will be paid based on the following schedule for 2020:

Tax Bracket/Rate

Single

Married Filing Jointly

Head of Household

0%

$0 - $40,000

$0 - $80,000

$0 - $53,600

15%

$40,001 - $441,450

$80,001 - $496,600

$53,601 - $469,050

20%

$441,451+

$496,601+

$469,051+


 While ordinary income is taxed at:

Tax Bracket/Rate

Single

Married Filing Jointly

Head of Household

10%

$0 - $9,875

$0 - $19,750

$0 - $14,100

12%

$9,876 - $40,125

$19,751 - $80,250

$14,101 - $53,700

22%

$40,126 - $85,525

$80,251 - $171,050

$53,701 - $85,500

24%

$85,526 - $163,300

$171,051 - $326,600

$85,501 - $163,300

32%

$163,301 - $207,350

$326,601 - $414,700

$163,301 - $207,350

35%

$207,351 - $518,400

$414,701 - $622,050

$207,351 - $518,400

37%

$518,401+

$622,051+

$518,401+

Since HCM’s Dividend Growth Portfolio™ is built with individual stocks, it is much easier to manage the tax implications of the portfolio through gain and loss harvesting of individual securities.  This is something that simply can’t be accomplished with a fund.

Conclusion

In order for you to retire well, you’ll need reliable growing income in retirement.  That means income will be received by you that is in cash, dependable, diversified, and growing faster than inflation. A Dividend Growth Strategy satisfies these criteria, allowing you to enjoy a full and happy retirement.  Talk to an HCM Wealth Advisor today to learn about how this strategy can apply to you.

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