Using Dividends for Income: Fixed-Income Investments
By Gary Silverman, CFP®
A common request of people who come into my office is that they want an investment portfolio to provide retirement income without having to ever sell something. Their thought is that they don’t want to raid principal but only want to live on dividends and interest. Well, that is very doable…but is it advisable? Let’s take a look.
Interest is what comes off of bonds and other fixed-income investments like CDs, fixed annuities, and even savings accounts. Dividends make up the interest-like income that comes from stocks. First we’ll look at bonds and such.
When you invest in a fixed-income investment, the deal is you give a lump of money in exchange for a guaranteed income. One problem is that guaranteed is not completely guaranteed. First, the company that is paying the fixed income might go out of business. No company, no income. And while you could limit yourself to only the highest rated companies, remember that during the financial crisis some companies with the highest rating a year before didn’t exist the year after.
“Okay,” you say, “then I’ll just buy U.S. Government bonds. The government isn’t a company and thus can’t go out of business, so I’ll be safe.” Still, let’s not forget that a country can go out of business by being taken over by another country; a government can be eliminated by a civil war; or a government can default on bonds. However, while very few things that happen with investing surprise me, I would truly be surprised if any of these happened to the United States during my lifetime, so for argument’s sake let’s assume the bonds are “safe”. (A brief aside…I can see Congress being stupid sometime and not passing budgets so that our bonds temporarily stop paying…but nothing that would last for long or that would generate a true loss of income…just a delay.)
While buying U.S. Government bonds might solve the problem of bonds not paying, we then have the problem of bonds not paying enough. As of this writing, the income payout of AGG, one of the larger and broad-based bond ETFs out there, is currently yielding 2.4%. Although the yield will change, my point is that most people will find it difficult to fund a retirement if their investments are producing only 2.4% of income.
Yet the low income isn’t the only problem. Likely as time goes on what costs you one dollar today will be more expensive a year or 10 from now. Fixed-income investments don’t grow in value. For instance, if you buy a $100,000 5-year CD today that pays 2% interest you’ll get $4000 each year of income and at the end of 5 years your $100,000 investment will be worth…wait for it…$100,000. Now, if things cost more in the future but your investment base hasn’t grown, how can you afford it?
Maybe dividend-paying stocks are the answer. You could buy some solid companies paying a good dividend, live on the income and let the stocks grow in value across time.
We’ll look at that next week.
Gary Silverman, CFP® is the founder of Personal Money Planning, LLC, a Wichita Falls retirement planning and investment management firm and author of Real World Investing