How Dividend Investing Fits Into Retirement Portfolios

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There’s that sweet, sweet cash flow.

Investors have been collecting dividends for centuries, but that doesn’t mean the investment approach is stale, or even well understood. Advisors serving retirement savers see dividends playing an evolving role in client portfolios, especially as equity markets remain historically concentrated. While that dynamic has rewarded investors in recent years, it has also raised questions about diversification, downside risk and portfolio resilience. In this context, advisors may want to give dividend investing another look.

“Dividend strategies generally aren’t going to knock the cover off the ball when the market is ripping,” said Nick Puncer, managing director and portfolio manager at the dividend-focused investment firm Bahl & Gaynor. “Conversely, you would probably be happy that you owned them if it is falling precipitously. They also can play an important role in income-focused retirement portfolios.”

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Virtues and Foibles of Dividends

Dividends reflect real company profits and a commitment to shareholders, Puncer told Retirement Upside. The consistent payment of dividends indicates business stability and offers predictability, which is appealing to retirement investors. “Warren Buffett said it well,” Puncer said. “The market is a weighing machine in the long run. If we own companies that are consistently providing tangible cash flow over long periods, market price should follow that over time. It’s not much more complicated than that.”

Financial advisors largely agreed, though most favor a blended approach. Since consistent dividend payers are generally more established and profitable companies, they usually come with less volatility and a “smoother ride,” said Ryan Salah, an advisor at Capital Financial Partners in Maryland. “That’s something retirees genuinely value,” he said “The regular cash flow can also feel reassuring when you’re no longer drawing a paycheck.”

However, a common misconception is that dividends are inherently superior to selling shares for income. That’s not true, as when a dividend is paid, the stock price drops by roughly that amount. Some other considerations:

In taxable accounts, dividends are taxed every year whether one needs the income or not.

Dividends can be used to satisfy required minimum distributions in qualified accounts, but they are taxed as ordinary income upon withdrawal.

Rather than building a portfolio around dividends, some advisors said they favor a total-return approach, owning a diversified mix and generating retirement income from a combination of dividends, interest and selective rebalancing.

A Skeptic’s Take. David Foster, an advisor with Gateway Wealth Management in St. Louis, isn’t a big fan of pure-play dividend investing. It’s certainly easy to convince clients of the value of dividend stocks because it sounds like “free money,” he said. “There’s nothing special about dividends as the value of the company paying the dividend immediately declines by the value of the dividend,” Foster added. Dividend portfolios also usually tilt toward value stocks rather than growth stocks. “If you had taken that approach rather than just owning the broad market over the last decade, your returns would have lagged,” he said.

This post first appeared on Retirement Upside. To receive actionable insights for financial advisors guiding clients through the strategies, products, and policy shifts shaping retirement outcomes, subscribe to our free Retirement Upside newsletter.