The Best Investment You Can Make for Retirement
The long-term cost of retirement scares a lot people. And for good reason.
Without earned income, you are dependent on Social Security, your private pension (if any), and whatever financial assets you’ve accumulated over a lifetime of working, saving and investing.
Making the challenge greater still, Americans are living longer than ever. And the average human life span is increasing each year. That means your investments have a lot of heavy lifting to do. (After all, you don’t want your portfolio to kick the bucket before you do.)
What is the best asset to make your retirement dreams come true? It’s no contest: dividend-paying stocks.
Dr. Jeremy Siegel, a professor of finance at The Wharton School of the University of Pennsylvania, did a thorough historical investigation of the performance of various asset classes over the last 200 years, including all types of stocks, bonds, cash and precious metals.
His conclusion? Dividend stocks outperform everything else over the long haul - and almost certainly will in the future, too.
During market declines, dividend-paying stocks hold up better than nondividend-paying stocks, often fighting the broad trend and rising in value. There's a good reason for this. Dividend payers tend to be mature, profitable companies with stable outlooks, plenty of cash and long-term staying power.
Bear in mind, U.S. companies are sitting on a record amount of cash right now, more than $2 trillion. Most corporations are hiring slowly (if at all), and they're not boosting spending. So a lot of this cash is rightfully going back to shareholders.
Over the last 50 years, the highest 20% yielding stocks in the S&P 500 returned 14.2% annually. That's good enough to double your money every five years - or quadruple it in 10. And if you were even more selective, say investing only in the 10 highest-yielding stocks of the 100 largest companies in the S&P 500, your annual return would have been even better, 15.7%.
This is where investors planning for retirement should be putting their money to work today.
After all, bonds - which should carry a warning label at the moment - are sporting record-low yields. (And their market value will decline as interest rates rise.) Money market funds pay less than one-tenth of 1%. But many dividend-paying stocks are reasonably valued and will boost their payouts substantially in the years ahead.
Over the past 50 years, the S&P 500’s dividends have grown an average 5.7% a year, well ahead of the average 4.1% inflation rate. The key for retirees is this creates an income stream that is growing faster than inflation, maintaining and increasing your purchasing power.
A couple of caveats here. You can expect stock prices - even dividend-stock prices - to decline sharply from time to time. Retirees have to be prepared for this, not only financially (with a reasonable amount of monthly living expenses set aside) but mentally. If you’re living off the income stream - and therefore don’t have to sell - you can ride out the downturn and wait for the eventual recovery.
Also, while dividends are far less volatile than stock prices, they do go occasionally get cut. Between late 2008 and early 2010, for example, companies in the S&P 500 reduced their dividends by 24%.
But this was during the biggest financial crisis since the Great Depression - and dividends were soon on the upswing again.
In short, bonds leave you vulnerable to the ravages of inflation. Stocks offer inflation protection: share price appreciation and rising income.
That’s why I say that if you want growth, you should invest in dividend stocks. If you want income, you should invest in dividend stocks. If you want to reduce portfolio risk, you should invest in dividend stocks.
If you expect to live a long and comfortable life, make them a centerpiece in your retirement planning.
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Editorial Note: If you're auditioning income-generating stocks for your portfolio, it's crucial that you consider just how likely those dividends are to get cut. There are a number of factors to look at, including cash flow... historic payouts... potential growth... and more. To make performing this analysis easier, Marc Lichtenfeld has developed SafetyNet Pro. Subscribers can access this easy-to-use online database 24 hours a day. Click here to learn more.