Dividends for Retirement

 

Dividends Can Play Key Role in Retirement Income Plans With stellar equity returns harder to come by, market volatility on the rise, and the huge baby boom generation entering retirement, stock dividends

Tax Act, which lowered the tax rate on dividends to 15% through 2010. Last year, dividend payments on the S&P 500 Index totaled a record

rate of 5.9% for the 20 years ended 2007, compared with the 3.1% annual rate of ination. To illustrate the potential advantage

are becoming afor more important consideration many investors. In roaring bull markets, such as the latter half of the 1990s, investors were not so concerned with dividends because they contributed relatively little to total returns. Indeed, many corporate managements pursued strategies designed to boost their stock prices and downplayed dividends. In the current decade, however, reinvested dividends have provided  of the return on the S&P 500 all  of Index as of June 30. Moreover, over the long haul, dividends have proved to be an important source of equity returns. Since 1980, for example, reinvested dividends accounted for more than half of the total return on the S&P 500 Index. So if equity returns are relatively modest over the next few years as many expect, dividends could be a more significant factor in returns. Market research research indicates that, th at, over the long run, companies with strong records of paying dividends have outperformed, and that such stocks can provide a cushion during periods of steep market declines—a particular concern for retirees who need shock absorbers in their portfolio during such rocky times.

$247 a two-thirds increase from billion, $148 billion paid in 2002. Almost 300 companies in the index announced dividend increases or initiations, averaging a 20% boost. Although the hard-hit nancial sector, which accounts for more than a quarter of dividend payments, has announced dividend cuts of almost $12 billion this year, total dividend payments are still expected to rise again for 2008. Retired investors and those

of a strategy focusing with higher dividend yieldson in stocks retirement, Ned Davis Research, a market research firm, tracked the performance of two equity portfolios—the S&P 500 and one comprising the top 50% of dividend payers in that index each year. The study assumes the investor retired with $500,000 at the end of 1972, just before the 1973–1974 bear market—one of the worst bear markets ever. The investor withdrew 4.5% of assets the first year, with

transitioning into retirement should consider the potential advantages of a dividend growth strategy before they switch to fixed-income securities in their portfolios. Because many companies that pay dividends steadily increase them over time, stocks can provide a growing level of income that maintains its purchasing power. Even as dividends generally declined in popularity over the past two decades, the dollar amount of dividends on stocks in the

annual ination of withdrawals tiedadjustments to the consumer price index. Annual withdrawals grew from $22,500 the first year to $106,835 in 2007. As seen in the chart below, the high-yielding stock portfolio provided all the withdrawals but still had a balance of more than $4.4 million at the end of 2007, while the S&P 500 portfolio ran out of money in 2005. Because dividend growth historically has kept up with or outpaced

S&P 500 grew at an annual compound

ination, an equity portfolio focused

High-Yield ield Equity Strategy in Retiremen Retirementt Benefits of a High-Y Annual Account Value of High-Yield Equity Portfolio vs. S&P 500: 1972–2007* $5,000,000 4,000,000

■  ■ 

High-Yield Stock Index S&P 500 Index

3,000,000

Equities for Income With the huge baby boom generation moving into retirement, “more and more investors may start to view equities as they once did—as a source of yield,” notes Jason Trennert, managing partner and chief investment strategist of Strategas Research Partners. Certainly, total dividend payments have increased sharply since the 2003 10

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2,000,000 1,000,000 0 -1,000,000

’72 ’74 ’76 ’78 ’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 ’04 ’06

*This analysis assumes a $500,000 portfolio in each strategy on December 31, 1972; 4.5% of portfolio assets withdrawn the first year of retirement; and annual increases in withdrawals to keep pace with actual inflation. Withdrawals Withdrawals are made at the end of each year. The high yield equity portfolio consists consists of the top 50% of dividend-paying dividend-paying companies in in the S&P 500 Stock Index, adjusted every January based on the prior year. Sources: T. Rowe Price Associates. Data supplied by Ned Davis Research.

 

provided an annualized return of 10.2% compared with 7.9% for companies that paid dividends but did not increase them and only 1.8% for non-dividend-paying stocks. This means that $100 invested at the start of the period grew to $3,413 for the firms raising dividends, compared with $1,584 for those that didn’t and $191 for the non-dividend-payers. Dividends also have provided some downside protection in market declines. During the bear market from March 24, 2000, to October 9, 2002, for example, the S&P 500 Index plummeted 49.1%. But Standard & Poor’s “Dividend Aristocrats”—companies that had increased their dividend for 25 the 1980s and 1990s, the dividend those planning ahead for retirement consecutive years— gained  15.5%,   15.5%, and those who have recently retired. payments surged ahead. according to Strategas. Over this entire 35-year period, And in the market decline from Other Characteristics the high-yielding equity portfolio Dividend-paying stocks can not only October 9, 2007, through March 10, generated more than twice as much 2008, the Aristocrats declined 14.8% income as the bond portfolio—about provide a steady source of income, compared with an 18.6% fall for the $476,000 in dividends compared with but they also can offer favorable S&P 500. relative performance over longerabout $230,000 in interest income. Of course, these Aristocrats did term periods. Moreover, in terms of principal For example, Ned Davis Research less well in a stronger market. For value, the original $100,000 investthe five-year period straddling these calculates that from 1972 through ment in the stock portfolio had 2008, compan companies ies in in the SS&P &P 500 two market slides, the overall index grown to more than $711,000 by the  June 2008, gained almost 102% compared with that have consistently increased or end of 2007, compared with about on dividend-paying stocks also has the potential over the long run to provide as much or more income than a portfolio of fixed-income securities, even though current yields on bonds typically exceed those on stocks. The chart below shows the annual income generated by the same high-yielding equity portfolio noted on page 10 and a government bond index, assuming a $100,000 investment in each at the end of 1972 and that each year’s dividend and interest payouts were taken in cash rather than reinvested. In the high-ination 1970s, as bond yields reached double digits, interest payments substantially exceeded dividend income. But as interest rates declined steadily over

growth vehicles. In the short run, equities, of course, are more volatile, so the investor has to be willing to live with the inevitable ups and downs of the stock market.” Mr. Rogers suggests that those who rely on their portfolio to help meet current expenses might consider a dual income strategy combining stocks and bonds because the stock dividends can supplement the bond interest now, can grow over time, and may be accompanied by appreciation of the equity portfolio. Although the current yield on stocks in recent years has been relatively low—about 2% or less—the generally steady growth in dividends over time can ultimately provide a significant level of dividend income, both for

$121,000 for the bond portfolio. started making their dividend payouts about 90% for the Aristocrats. Brian Rogers, T. Rowe Price Annual Income From High-Yield Equities vs. Government Bonds* chairman and manager of the Equity Stock Dividends vs. Bond Interest on $100,000 Portfolio: 1972–2007 Income Fund, observes: “First, stocks $25,000 tend to give you better protection ■  High-Yield Stock Index 20,000 against ination over the long term, ■  Government Bond Index and the advantage of higher-yielding 15,000 stocks is that they tend to provide 10,000 more defensive protection in adverse 5,000 market environments. “Secondly, dividends tend to grow 0 ’72 ’74 ’76 ’78 ’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 ’04 ’06 over time and protect the investors’ *This analysis assumes stock dividends and bond interest generated by the equity and bond real purchasing power. That can’t be portfolios, respectively, respectively, are taken in cash each year year.. The high-yield equity portfolio consists

said for most fixed-income securities. While bonds generally provide a higher level of initial income, equities can be viewed as better income

of the top 50% of dividend-paying companies in the S&P 500 Stock Index, adjusted every January based on the prior year year.. The bond index represents the S&P Long-Term Government Bond Index. Sources: T. Rowe Price Associates. Data supplied by Ned Davis Research.

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