Dividend Stocks vs. Fixed Income: Which Is Better for Retirement?

Many retirees who are seeking current income from their assets invest in fixed income securities, most of which provide a stable stream of income. Fixed income investments do have some disadvantages relative to stocks that pay dividends, and thus retirees which fail to account for these, could end up with no income at the worst time possible .

First, while typical fixed income securities provide a dependable income stream, its purchasing power is typically eroded by inflation. Even at 3% per annum, the purchasing power of one dollar decreases by 50% in 24 years. Double that inflation rate to 6% annually and now the purchasing power of one dollar is down by 50% in 12 years and by 75% in 24 years. Stocks that pay rising dividends provide the best inflation proof source of income. Dividend based distributions can grow, interest based distributions usually don't. Unless interest income is reinvested, the interest income cannot grow over time to compensate for the eroding value of inflation.

Second, right now qualified dividend income is taxed at 15% for the highest tax bracket in the US, which is almost half the top tax for interest income in the States. In Canada dividend income also received a preferential treatment relative to fixed income.

Third, bonds typically don’t increase their interest payments if the business is doing well. Stocks, which represent partial ownership of companies, tend to share higher profits with shareholders either through dividend increases or through stock buybacks. Thus stocks tend to provide higher total returns over time as they could provide higher capital gains and higher dividend incomes.

Stocks have disadvantages as well however.

First, if a company goes under and declared bankruptcy, fixed income holders are the only ones that get at least some return of their investment. Stockholders on the other hand typically receive nothing when the company emerges from bankruptcy.

Second if a company faces financial difficulties it could easily afford to cut or eliminate its dividends, but it would have to go through huge hurdles before it could get bondholders to agree to reduce or eliminate their interest payments.

Fixed income securities guarantee a return of your investment some time in the future, whereas stocks don’t provide that.

That being said I do believe that the best strategy for long-term investors is to have an allocation to both stocks and bonds. Fixed income tends to provide dependable income even in the worst bear markets. In addition to that fixed income investments provide diversification in bear markets and are the only asset to provide returns to investors during deflationary periods.

Stocks are great vehicles to own during average and high inflationary periods, and they could provide investors with rising inflation adjusted streams of dividend income over time. There are companies which have long records of raising their distributions. The possibility of receiving rising dividends from stocks, make equities a preferred method of investment for many investors. Some early holders of stocks like Johnson & Johnson (JNJ), Exxon Mobil (XOM), and Altria (MO) are now enjoying double or even triple digit yields on cost on their original investments, even without reinvesting their dividends. Similar investments even in the safest highest yielding fixed income securities would still be generating the same incomes, provided that they have not matured.

Currently I like several dividend stocks, which have the best prospects to grow their distributions over time.

Johnson & Johnson (JNJ) has increased dividends for 47 consecutive years. Johnson & Johnson engages in the research and development, manufacture, and sale of various products in the health care field worldwide. Check my analysis of the stock.

Mcdonald’s (MCD) has increased dividends for 32 consecutive years. McDonald’s Corporation, together with its subsidiaries, franchises and operates McDonald’s restaurants in the food service industry worldwide. Check my analysis of Mcdonald’s.

Chevron (CVX) has increased dividends for 22 consecutive years. Chevron Corporation operates as an integrated energy company worldwide. Check my analysis of Chevron.

Abott Labs (ABT) has increased dividends for 37 consecutive years. Abbott Laboratories manufactures and sells health care products worldwide Check my analysis of the company.

Clorox (CLX) has increased dividends for 32 consecutive years. The Clorox Company manufactures and markets a range of consumer products Check my analysis of the stock.

Disclosure: Long ABT, CLX, CVX, JNJ, MCD, MO

Comments

[jculley:]

"The company currently yields and trades at times/earnings."

You forgot something in that sentence.

Sep 23 10:11 AM

[No Free Cake:]

"Fixed income securities guarantee a return of your investment some time in the future, whereas stocks don’t provide that."

Not true. You could argue that US Treasuries and US agency bonds "guarantee" a return but that's certainly not true for other fixed income securities.

I'd also take exception to your statement of "Stocks are great vehicles to own during average and high inflationary periods, ...".

You need only look at the US in the 1970's, which is the most recent period of high inflation, to realize that equities performed poorly during high inflation. I agree that modest inflation doesn't impair equities.

Sep 23 12:12 PM

[User 490562:]

The credit crisis has caused the the stock price of a lot of good companies to come down, causing the dividend yield to rise. When this happens I view my stock as a bond. I'll collect the higher yield and wait for the share price to rise. Then I try to determine if the company has what I consider a "good" business model and base my decision to sell or hold on that basis.

Sep 23 04:47 PM

[Dividend Gr...:]

It's fixed. Thanks for your input.


On Sep 23 10:11 AM jculley wrote:

> "The company currently yields and trades at times/earnings."
>
> You forgot something in that sentence.

Sep 23 05:02 PM

[Dividend Gr...:]

NFC,

I had US Fed Govt obligations in mind. I should have made that clearer.

I disagree that stocks are not good vehicles to own during higher inflationary periods. Stocks did much better than bonds in the 1970s and they also provided a decent increase in dividends paid over that decade.
I guess it truly depends on what you consider a high inflation environment however. I read somewhere that in Zimbabwe, which had a huge hyper inflation, stocks managed to provide positive total inflation adjusted returns.

I guess I could have also written about TIPS, although this would certainly cause a discussion of whether the CPI accurately reflects inflation or not, which is not the purpose of this article.


On Sep 23 12:12 PM No Free Cake wrote:

> "Fixed income securities guarantee a return of your investment some
> time in the future, whereas stocks don’t provide that."
>
> Not true. You could argue that US Treasuries and US agency bonds
> "guarantee" a return but that's certainly not true for other fixed
> income securities.
>
> I'd also take exception to your statement of "Stocks are great vehicles
> to own during average and high inflationary periods, ...".
>
> You need only look at the US in the 1970's, which is the most recent
> period of high inflation, to realize that equities performed poorly
> during high inflation. I agree that modest inflation doesn't impair
> equities.

Sep 23 05:06 PM

[THofler:]

Ben Graham recommended that an "Intelligent Investor" never hold less than 25% fixed income and never less than 25% stocks at any age. He also liked preferred stocks, but only if purchased at a steep discount.

Sep 23 11:31 PM

[tipalia:]

I am taking the same path that user 490562 and right a good example of that is ABT . It s a matter of fact I will be buying more today if it trades below 46$ again.
Thanks for your articles and free analysis Dividend For Growth . All your input is much appreciated to small investors like me that share your views of investing.

Sep 24 08:56 AM

[tipalia:]

....and right now a good example... Sorry

Sep 24 08:58 AM

[Dotcom:]

ABT closed above $46 today, but may come back down with the rest of the market as it feels like deflation, not inflation, is the current theme.

I also know someone (not me, really) who owns only CD Ladders and does pretty darn good. His ladders are all 5 year investments, i.e. he built the first ladder with 1,2,3,4 & 5 year CDs and replaces the the 1 year with a 5 year when it reaches maturity... He owns at least 2 of these, maybe more in an IRA and stays below the $250K FDIC insured limits for any one bank...

Also TIPS are good when inflation is an issue. I don't think it's an issue today, but it will before too long.

Also Bill Gross yesterday said Treasuries are now a good investment, even with yields lower than they were last year before the bottom fell out. I'll have to think about that one, but I have high regard for Mr. Gross.

So - Dividend Paying Stocks, Bonds (Corporate, High Yield, Muncipal, TIPS & Treasurys (of some term), CDs and Cash (if you can find somewhere other than a Money Market to keep it in seems like a good bunch of assets to be invested in and balanced according to age, risk tolerance...

Sep 24 05:59 PM