How to invest for income
We have solid savings so now we want to get some dividend-paying stocks to provide retirement income. Do you have any suggestions?
NEW YORK (CNNMoney.com) - My wife and I both contribute 8 percent to our 401(k)s and $200 a month each to IRAs. We have a little over $500,000 in total retirement savings (401(k), rollover IRAs and IRAs). I just turned 40 and am thinking about investing $100 a month or so in dividend-paying stocks to provide retirement income. What do you think about this plan - and do you have any suggestions for the top-five dividend-producing stocks over the past 10 to 20 years.
- Lou, Pittsburgh, Pennsylvania
I can see why adding some dividend-paying stocks to a diversified retirement portfolio - or any well-balanced portfolio of stocks and bonds, for that matter - is appealing. Qualified dividends now get the same favorable tax treatment as long-term capital gains with the tax rate maxing out at 15 percent vs. 35 percent for interest and short-term capital gains. And over the past five and ten years stocks that pay above-average dividends have outperformed stocks that don't (although that's more a testament to dividend-stocks' ability to stand up to market downturns better than growth-oriented issues, rather than a fundamental ability to outperform non-dividend-paying stocks over the long-term).
So there are certainly good reasons to add some stocks with dividend power to your holdings.
Proceed with some caution
But I'd be careful about going too ga-ga over dividends, especially since investment firms are hyping dividend stocks, funds and ETFs as if they're the cure for practically anything that ails you.
Fact is, if you own a diversified group of large-company stocks - say, an S&P 500 index fund or funds that invest in the kinds of stocks found in that and other broad indexes - you probably already own a decent slug of dividend shares. And focusing too heavily on dividends could leave you with a portfolio skewed toward certain sectors of the market, such as utilities and financials.
Besides, someone your age should still be focusing primarily on growth. You'll have plenty of time to move more of your portfolio into dividend stocks later on when you're ready to start culling more income from your portfolio.
But with those caveats in mind, I see no problem with building a long-term position in dividend shares with relatively small monthly investments, provided that five hundred grand you've got stashed away for retirement decently diversified (that is, includes large and small stocks and growth and value shares).
Stay away from individual dividend stocks
What I don't think is such a hot idea, however, is doing this with individual stocks. Why? Well, for one thing, even if you invest with a discount broker online, you're probably talking a commission of $10 or so per trade. Right there, you're probably giving up about two years' worth of dividend payments on a $100 a month investment.
And investing in individual dividend stocks involves more than just running your finger down a stock page to find stocks that are paying fat yields today, or have done so in the past. You need to know what's behind that dividend. Is the payout from profits so large it's unsustainable? Is the dividend likely to grow, or is it vulnerable to being cut?
I'm not saying that answering such questions is beyond the abilities of individual investors. It's not. But you've got to be ready to put in some research time upfront. You've got to invest in more than five stocks. (I'd say 20 at a minimum.) And you've got to be willing to monitor the progress of the companies whose shares you've chosen.
How to do dividends right
The fact that you've asked for a Top 5 list suggests to me that you're more interested in easy pickings, not putting in the time to build a coherent portfolio.
Which is fine. There's a lot more to life than analyzing dividend stocks. And you can get the dividends without the hard work by investing in a fund that specializes in dividend shares. (There are also ETFs that specialize in dividends, but, as with stocks, you must pay a brokerage commission to buy an ETF. So ETFs are more suited if you're investing a rollover, windfall or other large sum.)
So what funds should you consider for dividends? Well, as it turns out, my MONEY Magazine colleague Penelope Wang wrote a story not too long ago on that very topic that goes into all the details you need to know - and mentions several good funds to boot. So I suggest you check out her story.
After you've settled on a few funds that seem like reasonable candidates, you can learn more about them by plugging their ticker symbols into the "Get Quotes" box that appears at the top of this page, as well as every other page on our site.
If you and your wife keep up the good work you and your wife are already doing building your 401(k)s and IRAs and you start investing in dividend stocks as well, your cup should runneth over with income come retirement time.
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