Having an allocation to dividend-yielding stocks can be a good move for most investors, but for those who are in or nearing retirement, it’s a must.
Christopher Davis, senior mutual fund analyst with Morningstar, says many newly-minted or soon-to-be retirees are primarily in fixed income investment, and, as a result, risk prematurely running out of money.
“A lot of times people associate retirement with fixed-income investing," says Davis. "They need to be safer since they’re living on that money and need the income which fixed income provides. If you are just starting retirement, you have potentially 20 or 30 more years of life left and you need to be able to continue to grow your nest egg and protect it against inflation.”
Dividend-paying stocks, he says, offer components essential to anyone in this demographic, including a solid income stream, growth potential (for offsetting inflation) and less-than-average volatility for a stock.
Dan Genter, president, chief investment and chief executive officer of RNC Genter Capital Management, says a substantial allocation to stocks is key and the lion’s share of should be in dividend paying stocks.
“It is necessary just to provide enough income,” he says, adding that bond yields are so low right now—ten-year Treasurys are yielding less than 4 percent—you need to make it up on the equity side, which means having that position in high dividend-yielding stocks.”
"They still feel that bonds are for income and stocks are for growth," explains Genter. "While that may have had some merit in the past when stocks were growing at 20-25 percent. In the current environment, many people would be happy having 10 percent total return and a 4-5 percent.
Tom Huber, manager of T. Rowe Price Dividend Growth Fund, says it’s important that a stock have a good current yield and the the opportunity for good dividend growth over time.
“I look for companies that may not be yielding 4-5 percent or even 6 percent, but have good dividend growth opportunities going forward,” says Huber.
Huber says consumer staples are a good example because the group “is a traditional area for healthy dividends and good dividend growth ... a lot has to do with the stability of those business and their ability to turn out healthy profits in good and bad environments."
One stock in this category is Hershey , which is yielding about 3.3 percent and has a good track record of growing its dividend over time.
There are also some names in the telecom sector—where dividends used to be notoriously scarce—that Huber says are offering some decent yields, including AT&T, which is yielding about 6.7 percent.
Another name Huber favors is media company Time Warner , now yielding about 3 percent, having just raised its quarterly dividend by 13 percent. It is also a relatively cheap stock right now, trading at about 11 times forward earnings.
He also likes consulting and outsourcing company Accenture PLC . Though the stock is only yielding about 2 percent, he says the divident is up 50 percent and the company's business is set to improve as the economy recovers.
One thing Huber cautions investors to be aware of when selecting companies for their dividend allocation is whether the company will be able to maintain the dividend.
“Often when you see a very high yield, you may want to question the sustainability of the dividend,” says Huber. “Take another step in addition to looking at the yield. Look under the covers."
Genter of RNC Genter Capital Management sees good dividend opportunities in the consumer staples and health care sectors.
Some of the stocks he likes are Philip Morris International , which is yielding about 4.7 percent; Altria Group , which has a yield of just under 7 percent; Bristol-Meyers Squibb , with a yield of about 5 percent; and Abbott Laboratories , which is yielding about 3 percent.
All of these stocks, says Genter, have good dividend yields, are trading at or below market P/E ratios and will probably post 10 percent in earnings growth.
For investors who prefer to invest in a dividend-focused fund, Morningstar’s Davis likes the Vanguard Dividend Appreciation Index Fund . This fund, which has an expense ratio of 0.35 percent, tracks an index that contains companies that have increased their dividend every year for the past ten years. It also accounts for the financial health of the companies in the index so it has solid underlying holdings that are highly profitable.
There is also an ETF, the Vanguard Dividend Appreciation ETF , which charges 0.24%, that tracks this same index.
An actively managed fund that Davis likes is the T. Rowe Price Equity Income Fund . This fund, he says, shares many of the attributes of the Vanguard fund, including its focus on high quality companies. He adds that the manager of the fund, Brian Rogers, has been there for more than two decades and has done a good job finding and exploiting bargains. Though it is more expensive than the index fund—the expense ratio is 0.71 percent—Davis believes it is reasonably priced for an actively managed large value fund.
Davis adds that when choosing a dividend-focused mutual fund or ETF, pay attention to how the manager really invests.
“Don’t judge a book by its cover. Just because a fund has ‘dividend or income’ in its name, it may not suit an investor that is seeking income,” he says.