STA Weekly Report – How to Generate Income with Dividend Stocks
Written by Luke Patterson | Saturday, November 23rd, 2019
INSIDE THIS EDITION: How to Generate Income with Dividend Stocks Weekly Snapshot of Global Asset Class Performance Year-End Tax and Financial Planning Ideas 401k Plan Manager
For investors, it has been a challenge to generate income in a low-interest rate world. Usually, investors who are saving for retirement use dividend stocks are a crucial building block to this end – with reinvested payouts juicing returns during the preretirement phase and providing crucial income to retirees during the withdrawal phase.
Dividends have traditionally been one of the few constants in the world of investing, helping to buffer volatility in both good and bad markets and history has shown that, over the long-term, dividends provide a key component of total return. As interest rates remain low, investors are turning their attention to dividend-paying stocks.
Functions of Dividends
At a basic level, dividends are profit sharing. A share of
common stock represents an ownership interest in a company. Just as the owner
of a small business enjoys the profits of the business’ operations, so too does
a shareholder in a larger company. The dividend is compensation for the
investment made by the shareholder in the business.
Dividend Stocks Offer More Than Just Income
The once sleepy world of dividend investing is showing signs of life. With their attractive income and yields, dividend stocks not only offer solid returns in an era of ultralow bond yields that doesn’t appear to be ending soon but also hold the promise of price appreciation. The S&P 500 index’s yield is around 1.9%, just above the yield of the 10-year U.S. Treasury note.
Dividends also offer a number of advantages beyond income,
one being that qualified dividend income is taxed as a capital gain and lower
rate than ordinary income receives. The top federal capital-gains rate is
23.8%. Payouts can also help buffer volatility in tumultuous markets, providing
returns even if a stock’s price goes down, and give a stock portfolio much
needed diversification. All of these attributes make dividend stocks an
important investment for the diligent investor.
Interest and Dividend Strategy
In a pure income approach, investors incorporate dividend
stocks and often an allocation to bonds to dampen stock market volatility. It
essentially entails setting up a diversified portfolio and living off the
dividends or using them to supplement other income sources in retirement. In
this approach, you rely on investment income only, without touching growth or
the original investment. A $5 million portfolio with an average dividend yield
of 2%, for instance, would throw off $100,000 a year before taxes.
Total Return Strategy
There are primarily two schools of thought on how to best
employ a dividend stock strategy: total return or pure income.
A total return strategy aims to generate a targeted annual return from all sources (interest, dividends, and growth), and may or may not involve touching the original investment. Total return for stocks includes dividends as well as capital appreciation (or losses) to give investors the ability to take distributions from a combination of yield income and price appreciation. Most institutional investors – university endowments and pension plans – are now following a total-return strategy to meet their funding needs, making their portfolios less susceptible to the fluctuations of the market. You can do the same.
A total-return approach should be based on a holistic view
of the portfolio, matching the asset allocation to your (the investor’s)
risk-return profile, using diversified investments and minimizing costs.
Dividend-focused equities tend to display a significant bias
toward value stocks. Until recently, value stocks have underperformed growth
names for several years. You should understand that you are changing the
composition of the risk profile of your portfolio if you are doing it for the
sole purpose of cash flow.
Total-Return with Guaranteed Income
In this approach, you use predictable sources of income (such as Social Security, a pension or annuities) to cover essential expenses. Remaining assets are invested in a diversified portfolio to generate interest, dividends, and growth. This approach may or may not involve selling or tapping your original investment.
High Dividends May Suggest High Risk
It is important to remember investments that offer higher levels of returns usually come with a higher degree of risk. Investors should be wary of chasing high-yielding stocks, for instance, given that a high yield is sometimes a signal of stock with deeper problems. Remember, there’s always a reason for that extra yield, and it would be that there is a lot of extra risks.
If you are considering investing in a stock with large dividend yield, proceed cautiously.
Investors should take care not to create an unbalanced
portfolio that’s too focused on stock income or too heavy in richly valued
What’s more, dividends are not guaranteed. While companies typically strive to maintain dividend payments once they’ve been initiated, they can be cut in times of duress. During the financial crisis, for example, General Electric cut its annual dividend from $1.24 a share to 40 cents. It’s now down to four cents a share annually! GE is a onetime dividend stalwart, with decades of consecutive payout increases until the first cut in 2009.
Whatever approach is used for investment income, dividends
should play a key role – but it’s important to understand where and how they
fit in a portfolio.
Weekly Global Asset
Year-End Tax and Financial Planning Ideas
Written by Scott A. Bishop, MBA, CPA/PFS, CFP® and Michael Churchill, CPA/MSPA
The end of the year presents a unique opportunity to self-reflect about your personal financialplanning situation. With factors like tax law changes, life changes, or simply working towards your goals, now is an especially important time to review things. It is always a good time to see if you are on-track at your stage in life. Taking what we now know about the new tax law, the Tax Cuts and Jobs Act of 2017, and weaving together all of the other areas of your personal finances is one of the key ways we provide value to you as your trusted advisor. Below are some things we’d like to help you think through before the year ends.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA Wealth Management, LLC. Please remember to contact STA Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. STA Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees continues to remain available upon request.
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