This piece originally appeared in the December 2017 edition of Indexology Magazine.
If you're getting up there in age, as I am, you are looking to eventually retire. And while that does not necessarily mean you will stop working, it does likely mean a reduction in current and expected income. It also means needing to live on what you will now be generating and protecting that income and principal.
Looking for income in today’s lowrate environment, where the Fed has increased rates twice this year and is expected to do so one more, is a relatively poor search, as interest rates have actually declined yearto-date (the 10-year is at 2.30%, compared to 2.45% at year-end 2016 and 2.27% at year-end 2015). While some bank instruments have inched up, it is not enough to change the risk/reward tradeoff, as they remain uncompetitive with yields, especially given the reduced tax treatment of qualified dividends. Bonds yields are competitive, but with no tax advantage, and unless you are able to hold them until maturity, higher interest rates could erode your principal if you need to sell them; additionally, fixed rate instruments do not necessarily move up with interest rates. Preferred issues also tend to have a higher yield, but their rate may not be impacted by interest rates increases, with most not having a tax advantage. In the current environment, income seekers have very few choices, with dividends having very little in the way of competition, which could be adding to their lower growth rate. Adding to the current dividend bandwagon is the market, where the aging bull continues on, setting new highs, and companies slowly play catch-up with their yields, which have declined as prices outpaced dividend increases.
The way I look at it, dividends could become my “paycheck” in retirement, and while pay raises are nice, the paycheck needs to continue to come in, even without the raise. That means I could look to companies with a history of paying and increasing dividends, as well as sufficient earnings and cash flow (can’t write a check against proforma earnings) from current operations to cover the dividend and grow the business. The company doesn’t have to do great or even set records, but they do need to have a stable product line that I am comfortable with going forward, and the potential upside of longer-term capital appreciation (so they can increase the dividend).
