Securities that pay dividends are one investment option for retirement portfolios. Dividends are cash payments made quarterly or annually to people who own stock in a given company. The company pays for these dividends out of its annual earnings. Generally, established companies with clearly defined markets pay dividends, while newer companies that are still growing their product lines don’t issue dividends. A company’s board of directors determines whether to pay dividends at an annual meeting and sets the dividend price on a per-share basis. For example, a company might pay a 50-cent dividend for every share owned in the company as of a certain date.
Pros and Cons of Dividends
Dividends provide certain ongoing cash payment versus potentially larger returns at some point in the future. The advantage of dividends is that you receive cash for your investment without having to sell your stock and decrease your ownership in the company. Companies use dividends to reward investors for buying and holding their stock.
However, there are two downsides to dividends. By paying dividends from its earnings, a company limits its ability to grow since it can’t invest those funds to expand its production or markets. While you receive a cash benefit now, you limit the potential growth of the company and could lose out on a much larger gain later.
Second, dividends are taxed as ordinary income, while the proceeds from selling stocks are generally taxed at a lower rate. If a company kept the money and expanded its market, the stock price would likely increase. You could then sell a portion of shares to make up for the lost dividends, and that amount would be taxed at a lower rate.
How to Use Dividends in Your Retirement Portfolio
While you should always consider diversifying your portfolio with different types of securities, you should own a higher percentage of dividend-paying securities during retirement. The quarterly dividend payments provide you with the cash you need to pay your expenses without having to sell shares. Before retirement, your goal is to increase the value of your portfolio as much as possible. You won’t need periodic payments to cover expenses, so you should maintain a lower percentage of dividend stocks in your retirement portfolio to maximize returns and minimize taxes.