How dividend investing fits into a retirement portfolio

Worried about an AI bubble? Sign up for The Daily Upside for smart and actionable market news built for investors.

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Investors have been collecting dividends for centuries, but that doesn’t mean the investment approach is outdated, or well understood.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.”

Sign up for The Daily Upside at no charge for premium analysis on all your favorite stocks.

Also read: Why does Uncle Sam want America’s Retirement Auto Enrollment? And Here’s how good tax advice can ruin a business owner’s Social Security check

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:

• In taxable accounts, dividends are taxed every year, whether one requires the income or not.

• Dividends can be used to meet required minimum distributions in qualified accounts, but they are taxed as ordinary income upon withdrawal.

Rather than building a portfolio around dividends, some advisors said they favor a total-return approach, owning a diversified mix and generating retirement income from a combination of dividends, interest and selective rebalancing.

A skeptic’s opinion. David Foster, an advisor at Gateway Wealth Management in St. Louis, isn’t a big fan of pure-play dividend investing. It’s certainly easier to convince clients of the value of dividend stocks because it feels like “free money,” he said. “There is nothing special about dividends because the value of a company paying a dividend immediately decreases by the value of the dividend,” Foster said. Dividend portfolios also typically lean toward value stocks rather than growth stocks. “If you had taken the same approach over the last decade instead of owning the broad market, your returns would have lagged,” he said.

This post appeared first retirement upside down. To receive actionable insights for financial advisors guiding clients through strategies, products, and policy changes that shape retirement outcomes, subscribe to our free retirement upside down Newsletter.