As more Americans crack open their retirement nest eggs, many are turning toward dividend-bearing investments in a scramble for greater security.
"Baby Boomers have worked hard for their money, and now they want it to work for them," said Josh Peters, equities strategist and the editor of Morningstar's DividendInvestor.
"There's a pretty good opportunity to capitalize on that need," he said.
And in recent years, companies have done just that. During the late 1990s, 220 S&P 500 Index member companies, or 44% of the index, issued dividends. Often those companies were painted as stogy and with little hope for growth. Meanwhile, companies that promulgated aggressive growth plans continued to sell shares long before those companies themselves broke even.
Investors' impressions of that strategy changed dramatically after the technology bubble burst in March 2000, followed by a bear market that trudged into 2002.
"Companies are saying to investors, We are out of great ideas,' and returning cash to shareholders," said Jeff Tjornehoj, a senior analyst with Lipper of New York.
Last year, 387 S&P 500 member companies sent dividends out to their investors, or 77.4% of the index, according to Lipper data.
"The pool of retirement money is so large, companies are going to have to be fairly progressive with their dividend policies," Peters said. "Most people are going to respond to dividends as a selling point."
Fund companies, too, have increased their dividend-paying options to investors, although since fees cut into dividend gains, many investors find them less appealing, Peters said. Financial planners are also capitalizing on the opportunity for their Baby Boomer clients.
"It's far more often that people think of investing with respect to the accumulation side as get as much as you can,'" said Heywood Sloane, a principal with DSG, a research and consulting firm in Wayne, Pa. "When you enter retirement, it's a whole different set of balls."
Suddenly, investors must plan for events they may not be able to foresee, for an unknown stretch of time into the future, and hope that they've saved enough, he said.
In June, DSG announced results of a survey it conducted in conjunction with Denver-based Financial Planning Association, which showed that 98% of financial planners recommend dividend-bearing stocks as part of a retirement plan, and 70% listed such stocks among their top two recommendations.
"Dividend-paying stocks have been the bread and butter of retirement income in the investment world for generations," Sloane said. It's also a concept that is easy for planners to explain to clients, especially compared to more complex products, such as variable annuities, because many investors are already accustomed to the idea of owning stocks and funds through their employers' 401(k) program.
Dividends are also dependable. "One of the things boards of directors do not like to do is to decrease dividends," Sloane said. "Knowing that, someone could make the case that it's fairly stable income."
Dan Genter is someone making just that case. Genter, president and chief investment officer of RNC Genter Capital Management in Los Angeles, expects the popularity of dividend investing to surge, as interest rates remain relatively low and Baby Boomers try to steer clear of volatility.
Such a total return strategy has been made even more attractive by the 2002 tax code revisions, which lowered the dividend tax rate from 35% to 15%, and put it on par with capital gains, Genter noted. In May, Congress extended that rate to 2010, although the law initially called for the rates to revert in 2008. Some think that in four years, the extensions will either be extended, or the tax code will be significantly rewritten.
"The real sleeper of this strategy is total return," Genter said. Although he advises wealthy clients, he believes his is a strategy from which anyone can benefit. Dividend stock investments should not replace other long-term or income-oriented approaches, he said, but the lowered tax rate coupled with low interest rates make dividend-returning stocks and funds more attractive than even municipal bonds and traditional treasury bills.
Genter's strategy is to pick only those stocks with average yields twice that of the market, and that have not reduced dividends in at least five years. Genter makes sure his portfolios are diverse by sector, with, as of the end of 2005, about 17% in industrials, 21% in financials 11% in materials and 15% in the dependable dividend-yielding standby sector: utilities.
RNC's 30-stock High Dividend Portfolio, which Genter runs, maintains a yield of 3.5%, compared to 1.8% for the S&P 500, as of January.
"It's nice to have 3.5% or 4% to start the year, which is bankable," Genter said.
Dividend-yielding holdings tend to perform better over the long-term, too. In the past three years, The S&P 500 returned 12.1%, compared to the Dow Jones Dividend Select Index, which returned 16.9%. Over the past decade, the Dow Jones dividend index returned 14.1%, beating the S&P 500 by 4.8 percentage points.
That's because companies that can afford to pay dividends tend to be financially sound, Genter said. "When you break down the elements of the benefits of this strategy, the dividend income is really icing on the cake," he added.
This combination of appreciation and income is especially attractive to those approaching retirement. "People are increasingly connecting those dots," Sloane said.
Finding high returns in dividend-paying mutual funds can be difficult, though. In a Lipper review of 5,396 dividend-paying equity mutual funds, 58.11% issued dividend income of 2% or less, while only 1.19% yielded dividend of 5%, and 0.57% returned dividends of 10%.
The danger is that as more and more investors adopt this strategy, dividend-paying stocks and funds will become inundated, pushing yields down, Tjornehoj said.
"It's a trap a lot of investors fall into," he said.
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