Best Investments for Retirement

NEW YORK (MainStreet) — Retirement portfolios that include a mix of dividend stocks and other assets can yield retirees the largest returns even when they are making withdrawals each year, according to a Bankrate.com analysis.

A portfolio tilted toward the Dividend Aristocrats Index (companies that have raised dividends each year for the past 25 years) beat the competition after testing multiple $1 million retirement portfolios to see which investment mix gives retirees the greatest returns, while delivering an inflation-adjusted income stream, said Bankrate.com.

An investor who retired in 2000 with a $1 million portfolio divided between the Dividend Aristocrats of 60% and an aggregate bond index of 40% would have had almost $1.8 million at the end of 2013. That even includes withdrawing 4% or about $40,000 each year while adjusting for inflation. The portfolio still came close to doubling despite the annual withdrawals.

That same scenario with an S&P 500 index fund instead of the Dividend Aristocrats would have only been worth $838,000 at the end of 2013 or less than half the Dividend Aristocrats-led portfolio.

Swapping the S&P 500 index fund for a group of more ordinary dividend-paying mutual funds would have been a little better of $1.2 million, but still far less than the Dividend Aristocrats example.

Retirees need an income stream that is also inflation protected and dividend-paying stocks can play a crucial role, said Greg McBride, Bankrate.com's chief financial analyst.

Companies which pay dividends tend to generate "pretty predictable profits," but also operate in larger and slower growing industries, which also experience less volatility in their stock prices, he said.

"Whether you are accumulating a retirement portfolio or living off of it, investors need to minimize volatility and dividend paying stocks provide that especially relative to non-dividend paying stocks," McBride said. "That dividend is an incentive to hang in there during periods of market turbulence because you are being paid to wait."

Investors can find broad-based mutual or exchange traded funds pegged to the Dividend Aristocrats Index to add to their portfolio, he said.

"Don't ignore those slower growing stodgier companies because the power of dividends offers tremendous compounding over many years," McBride said. "Dividends aren't just for retirees. They are just as important to include in that portfolio that you are eventually hoping to live off of in retirement."

Dividend-paying stocks tend to have higher returns because these stocks typically are older, slow growth companies that carry higher risks, said Christopher Van Slyke, CEO of Worthpointe, a registered investment advisor with offices in Austin and San Diego.

"A perfect is example is Google versus GM, the former being a growth company and the latter just emerging from bankruptcy," he said. "Building a dividend-oriented portfolio is really building a value stock portfolio. We know value stocks have higher returns. It's important to understand that you are giving up some diversification with this strategy. You need to clear about that when creating a dividend-paying portfolio."

Growth stocks are characterized by high growth rates for sales and earnings with earnings being reinvested to fund continued growth and pay no dividends, said Don Shelly, professor of practice in finance at the Cox School of Business at Southern Methodist University in Dallas, Texas. Value stocks have slower sales and earnings growth and have high dividend yields relative to growth stocks.

"Growth stocks are frequently associated with new technologies, the next "big thing" and are sometimes referred to as "glamour" stocks," he said. "If history repeats itself, investors will find over the long-term investing in dividend paying stocks will create more wealth than investments in growth stocks."

Stocks that pay dividends have a good track record of providing good performance over a full market cycle and can be advantageous during downturns in the market, said Joe Jennings, investment director for PNC Wealth Management in Baltimore.

"Many dividend paying stocks may be more defensive in nature, meaning that they truly shine during periods of market weakness," he said. "To help balance that defensive nature, one would consider more growth-oriented stocks that may pay little to no dividends but could lead to outperformance during the bullish phase of the market cycle. This sort of balance in a portfolio should lead to better diversification and help to smooth returns over time."

Dividend yields represented by the S&P 500 are likely to increase meaningfully over the next five to ten years, said Josh Rothé, portfolio manager for Azzad Asset Management in Falls Church, Va.

Dividend investing has its drawback, he said. Dividends aren't guaranteed - they're not a promise, nor are they a contract.

"For companies that have sustainable and generally predictable cash flows, they are both an important part of the total return equation and a powerful indication of what management believes their true underlying earning power to be," said Rothé.

The rate of growth for a dividend can slow down over time, he said.

"Not all dividends are created equal," said Rothé. "Slowing dividend growth can be an indication of changing capital allocation, but it can also point to deterioration in a company's fundamentals."

Investors need to have a critical eye and look beyond what level of income a dividend stock can provide currently, said Dustin Brumbaugh, director of research for D.A. Davidson's individual investor group in Seattle.

"We believe a high quality and diversified portfolio of companies can provide many benefits beyond simply income for today, including healthy capital appreciation, relatively low volatility and downside support in weak equity market environments," he said.

Many stocks which pay dividends could increase their payments in the future, said Britt Doyle, co-founder of Gordian Wealth Advisors in Mill Valley, Calif.

"We believe investors would rather own equity in a company they know that pays a good dividend, than own something they don't understand especially after the latest market downturn," he said. "What makes dividend paying stocks even more attractive now and going forward is the fact that dividend payout ratios are still hovering at 75% of historical norms which means that dividends on average still have a ways to go on the upside."

--Written by Ellen Chang for MainStreet

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