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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Investors have been collecting dividends for centuries, but that doesn’t mean the investment approach is outdated, or well understood. Advisors serving retirement savers see dividends playing an emerging role in client portfolios, especially as equity markets remain historically concentrated. While that dynamism has rewarded investors in recent years, it has also raised questions about diversification, downside risk and portfolio flexibility. In this context, advisors may want to give dividend investing another look.
“Dividend strategies are generally not going to cover the ball when the market is declining,” said Nick Punsar, managing director and portfolio manager at dividend-focused investment firm Bahl & Gaynor. “Conversely, if it’s declining rapidly you’ll probably be glad you owned them. They can also play an important role in an income-focused retirement portfolio.”
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Advantages and disadvantages of dividends
Punsar tells Retirement Upside that dividends reflect a real company’s commitment to profits and shareholders. Consistent payment of dividends indicates business stability and provides predictability, which attracts retirement investors. “Warren Buffett said it well,” Punsar said. “The market is a weighing machine over the long term. If we have companies that are consistently delivering solid cash flow over the long term, the market value should follow it over time. It doesn’t get more complicated than that.”
Financial advisors largely agree, although most favor a mixed 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. “This is something that retirees really value,” he said, “Having regular cash flow can also feel reassuring when you’re no longer drawing a paycheck.”
However, a common misconception is that dividends are inherently better than selling shares for income. This is not true, because when a dividend is paid, the stock price decreases by almost the same amount. Some other ideas:
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In taxable accounts, dividends are taxed every year, whether one requires the income or not.
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Dividends can be used to meet required minimum distributions in qualified accounts, but they are taxed as ordinary income upon withdrawal.
