Retirees need steady income
In all likelihood, the prices of goods and services will continue rising year by year. This may not be too much of a problem for you when you're working, because your salary is probably also going up over time. But when you retire, you may find that inflation becomes a bigger concern – and that's why you need to take steps to help provide some investment sources that have the potential for rising income during your retirement years.
Of course, as a retiree, you may feel that you need to invest more conservatively than you did when you were working. After all, you may think, you're no longer drawing a paycheck, so you can't really afford to take chances on investments that constantly fluctuate in value. Consequently, you may be inclined to stick with fixed-income vehicles, such as investment-grade bonds and certificates of deposit (CDs). When you purchase these securities you typically have the expectation that your principal will be preserved and you will receive regular interest payments. So, there's no risk involved, right?
Actually, that's not the case. Bonds, CDs and other fixed-income investments carry their own type of risk purchasing power risk. Suppose, for example, that your bonds and CDs provide you with interest income of $1,000 a year. Even with a relatively mild inflation rate of 3 percent, your $1,000 will only be worth $863.00 in five years, and $744.00 in 10 years. And if inflation picks up to 5 percent, the purchasing power of your $1,000 will drop to $774.00 in five years and to just $614.00 in 10 years.
Those are big drops. And if you spend two or even three decades in retirement – a definite possibility – you could lose even more purchasing power if you invest solely in fixed-income vehicles. That's why you need to consider investments that provide you with not just regular income, but the potential for rising income. That's why you may want to consider dividend-paying stocks.
You can now find dividend-paying stocks in a wide variety of industries, including financial services, food producers, consumer products, pharmaceuticals, technology, publishing and others. But in searching for stocks that pay good dividends, it's important not to be "short-sighted" and just go after those companies that seem to be paying the highest dividends at the moment. You need to be sure that a company's earnings are sufficiently strong to support its dividend payouts. If a firm's earnings are weak, it may well cut its dividends, thereby jeopardizing your income stream.
By doing some research, you can find many stocks that have actually increased their dividends for 25 or more consecutive years. Although past performance is not an indication of future results, that's a pretty good track record, and it's an indicator of strong, well-run companies who seek to reward their investors.
Still, as a retiree, you do need to keep two points in mind about dividend-paying stocks. First, they are not obligated to pay dividends, no matter how good their history they have the ability to increase, decrease or totally eliminate dividend payments at any time without notice. And second, they are stocks, which means their price can and will fluctuate so it is possible to lose some or all of your initial investment amount.
In short, dividend-paying stocks can be a valuable part of your portfolio during your retirement years – but you should also include bonds, CDs, government securities and other investments. By making the right moves, you can work to stay ahead of inflation without taking on an excessive degree of risk. And that's a winning combination.
Mike Jones is an investment consultant with Edward Jones. He can be reached by calling 332-7924