Topic: Dividend Stocks

Living on dividends in retirement is possible if you follow these rules

December 17, 2019|by Scott Clayton

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Practice a strategy of buying, holding, and watching carefully top-quality stocks during your investment career if you want to achieve the goal of living on dividends in retirement

Retirement planning is something you should start to think about long before you retire. But you don’t have to come up with a complete answer to it ahead of time, and don’t confine your planning strictly to the financial side. The abundant free time you’ll have in retirement could turn out to be a great asset, both from the financial point of view, and from the personal happiness and well-being it can deliver.

That said, dividends also play a very important role in retirement—and here’s one important factor to look for when searching for the best dividend paying stocks to buy: A history of 10 or 15 years, or five years of dividends, is kind of a pedigree for a stock. It tells you the stock has been looking after its investors for a good period of time.

And that record of dividend payments is something you can’t fake. So, it’s a very good idea in retirement to confine your buying to stocks that do have a dividend record, not just a current dividend. Below, we further discuss living on dividends in retirement.

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Take a “buy, hold and watch carefully” approach during your younger years if you intend to be living on dividends in retirement

Some people think that buy-and-hold means buy and forget about it. It really should be buy, hold and watch carefully—even with a dividend-paying stock with a pedigree. But when you build your retirement portfolio out of stocks that pay dividends, you have fewer unpleasant surprises and a better, more stable source of retirement income, from steady dividends and occasional capital gains.

We’ve always placed a high value on a strong record of paying dividends, mainly because it provides that pedigree of sorts for the stocks we recommend. It takes a lot of success and high-quality management for a company to have the cash and the determination to declare and pay a dividend every year for five or 10 years or more. It’s not something you can create on the spur of the moment.

Now many investors have come to share our high regard for dividends, especially as a source of retirement income. However, some take this reliance on dividend stocks to extremes. They put too much faith in a history of dividend payments. They think of a stock with a good dividend history as the next best thing to a government bond.

But it’s nothing of the kind. It’s a good sign, but not the only sign you need to look for. It takes continuing effort to succeed as a so-called “buy-and-hold” investor. You need to learn how to “buy and watch carefully.”

Here are characteristics of the best dividend stocks so you can invest more wisely

1. The best dividend stocks offer sustainable dividends: It’s important to watch out for unusually high dividend yields. Investors should avoid judging a company based solely on its dividend yield. That’s because a high yield can sometimes be a danger sign rather than a bargain.
2. The best dividend stocks will include these financial factors: As a general rule, companies that make money regularly are safer than chronic or even occasional money losers. If you only buy dividend-paying stocks, you’ll avoid most frauds. Furthermore, the more manageable the debt, the better. When bad times hit, debt-heavy companies often go broke first—especially ones that also keep trying to allocate part of their cash flow to paying dividends.
3. The best dividend stocks have hidden assets: Successful investors recognize that hidden assets are a great way to cut risk, for conservative and aggressive investors alike. One great example is research and development.

Use our three-part Successful Investor approach to select the top Canadian dividend-paying stocks so you can better enjoy your retirement

You still need to observe our three key portfolio rules, even when confining your investments to stocks with strong dividend records. They are:

1. Invest mainly in well-established, mostly dividend-paying companies.
2. Spread your money out across most if not all of the five economic sectors (Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance and Utilities). This cuts your risk of getting too heavily invested in an industry or sector that is headed for a slump. It also increases your chances of investing in a super stock with returns that are two to five times or more higher than the market averages.
3. Downplay or avoid stocks that are in the broker/media limelight. This limelight inflates investor expectations. When stocks fail to live up to those inflated expectations, downturns can be brutal.

Just remember that if you place too high a value on any single investment attribute, you may overlook signs of associated, or offsetting, risk. That’s something an investor needs to avoid at all times, but especially in retirement.

Some pundits disagree with the strategy of living on dividends in retirement because they claim it’s too costly. What are your thoughts?

If you plan to live on dividends in your retirement, what steps did you take to fulfill that plan?