Take a look at any retiree’s portfolio and you’ll see the same thing: it’s filled with high-yielding dividend stocks. For most golden-age investors, owning dividend-paying companies is a no-brainer. The income pays for day-to-date expenses, and research has shown that companies with a yield tend to post higher long-term total returns than those without. However, as many investors have learned over the past couple of months, owning dividend payers solely for the yield has its consequences.
The companies that retirees have gravitated to since the recession have been mainly in interest-rate-sensitive sectors, such as REITs and utilities. When bond rates rise, which they have this year, these stocks tend to fall in price as fixed-income products, which are safer to begin with, become more attractive. Because these sectors have been so popular, many companies have also become overvalued.
While retirees shouldn’t abandon dividend stocks, many investment experts are now looking for companies that provide a little growth with that income, rather than just a high yield. Jeff Turk, a portfolio manager at Cumberland Private Wealth Management, notes that because people live longer than they used to, portfolios need to increase in value, along with paying out a decent steady stream of cash. “Focus on investing in companies with good earnings and great growth that can grow their dividends,” he says.
Allan Small, a senior investment adviser with DWM Securities, likewise recommends growth-with-income stocks because they can beat inflation with a one-two punch, rather than just with capital gains or dividends. A portfolio that doesn’t grow and can’t index for inflation is technically losing value, even if returns don’t drop, he says.
The inevitable trade-off is that you will be taking on some additional risk; if the growth doesn’t materialize, the stock price could fall. But then the value of income stocks can fall too, as many have recently—especially if you overpay for them. Small adds that it’s just as risky to invest in the highest-yielding stocks. A large payout can often lead to a dividend cut.
The best buys for today’s retirement portfolio are companies that grow dividends annually and expand earnings every quarter, says Renato Anzovino, vice-president and portfolio manager with Heward Investment Management. He likes businesses that can grow earnings by 10% or more per year. “That will translate to 20% to 30% stock price appreciation over a few years,” he says.
Adding growth doesn’t mean buying the latest and greatest tech names, though. James Cole, senior vice-president and portfolio manager with Portland Investment Counsel, would rather see a company that has a long track record of steady growth than one that’s been soaring for a year or two. “I want to know what the company has done in the past,” he says. Some more growth-oriented companies have high price-to-earnings multiples, but if management has a history of improving the business, then it’s worth it. “If they have significant total return potential—dividend and principal growth—then there’s limited downside risk,” he explains.
Fortunately, these types of companies aren’t difficult to find. Small suggests looking at companies in the financial sector, while Turk sees opportunities in U.S.-based multinationals. But wherever you look, the message is the same: stop searching for yield and look for good operations that grow earnings and dividends instead. “Markets change,” says Turk. “People need to start investing differently.”
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With this Armonk, N.Y.–based technology giant, you’re getting a company that’s increased its dividend for 18 straight years and has a proven that it can grow its earnings over the long term.