When meeting with retirees, three topics usually come up: an update on their grandkids, their growing impatience with Minnesota winters and their desire for income-producing investments.
I typically respond: Show me the pictures, bring on the snow and careful what you wish for.
Retirees’ desire for income-producing investments makes sense. The interest and dividends these investments kick off should allow retirees to tap into less principal. This feels safer to many.
Yet at times, investors focus too much on income and ignore the risks that accompany these investments.
Even financially sound companies that pay hefty dividends can be risky, especially if you overpay for the stock. Investors have flocked to these companies over the past decade as bond interest rates declined.
Their reasoning was simple: Why buy a bond paying 2 percent interest when they can buy a stock paying 5 percent?
Many high-dividend companies are well-established and in low-growth sectors. Because of this, they historically sell at a discount to other sectors. These companies need to entice investors with dividends to compensate for lower growth prospects. Investors’ obsession with these stocks over the past decade drove many to rich valuations, and now interest rates are rising.
The 10-year U.S. Treasury flirted with 3 percent recently, its highest rate in nearly five years. In addition, the Federal Reserve is expected to raise interest rates at least three times this year. The higher rates on U.S. Treasuries, the safe haven for conservative investors, has investors reconsidering owning high dividend stocks. Utilities, real estate and telecom and energy, sectors known for dividends, have gotten clobbered so far this year – the four worst performing sectors in the S&P 500 by far.
The answer isn’t to discard all dividend stocks. Dividends are far from a bad thing. But if you are overweight high-dividend payers, take a hard look at what you own and why. If the only answer is it’s paying a high dividend, it’s probably a good time to re-evaluate.
Instead of focusing only on dividends, carve out room for undervalued companies that should appreciate over time. In the years these stocks rise, sell some profit. This profit becomes your income. It’s simply another way of looking at “income-producing” investments.
This strategy could lead to better results, which could mean more trips escaping Minnesota winters – maybe even with your grandkids.
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