9/20/2011 7:22 PM ET|
How to rescue your nest egg
With the market mired in malaise, it’s not easy to keep your 401k or IRA on track. So, you might want to focus on stocks and mutual funds that will pay you in any market.
There are troubling times for anyone trying to build a retirement nest egg. Because of credit meltdowns and government debt problems around the world, economies are seriously sputtering -- which means the market remains stuck in second gear.
The Standard & Poor's 500 Index ($INX) has advanced only 11.3% over the past decade and trades at levels first reached a couple of years before that. It's hard to build your 401k or individual retirement account when you're getting that kind of return.
What's worse, it may be a while before stocks break out again. Investors are so shell-shocked they are avoiding risk, shunning stocks for the perceived safety of cash or bonds. That doesn't help stock prices.
But there is way to keep your retirement plans on track -- pulling down a regular cash return that beats CDs or money-market funds, without missing out on the growth of stocks when the market turns up.
Bulk up on dividend-paying stocks.
Dividends fell out of favor during the go-go-tech days a decade ago, and they're often dismissed as tools for grandfathers in today's high-speed, trade-happy markets. But dividend-paying companies offer lots of advantages for all investors, in shaky times and in good times.
I've got a list of dividend funds and stocks for you that can help keep your nest egg growing. But first, here are the top three reasons dividend-paying stocks make so much sense right now:
1. Dividends pay
The most basic reason to bulk up on dividend stocks is that you get paid for owning them -- something that's particularly important right now, with bonds providing paltry returns. Since 1970, 10-year U.S. bonds have paid a yield that's typically 2.5 times more than the average yield on S&P 500 stocks. But right now, the S&P 500 pays a bigger yield than bonds for only the second time in 40 years, says Derek Rollingson, who manages the Icon Equity Income (IOEIX)fund.
In other words, dividend-paying stocks are a better source of income right now than bonds, something that may continue for a while with policymakers vowing to keep interest rates down.
Just two little facts show how critical dividend payments can be:
- From January 1926 through June 2011, the S&P 500 returned an average of 9.97% per year. Reinvested dividends -- payouts plowed back into their stocks -- accounted for 41.7% of that return, according to Standard & Poor's.
- And that 11.3% return for the S&P 500 stocks over the past 10 years actually triples to 35.2% if you include reinvested dividends, says Standard & Poor's.
2. Dividends provide safety
Regular payouts represent safety -- on many levels. First, dividends are a public statement of confidence by company boards and managers. They know stocks get crushed if a dividend is cut, so the promise to pay dividends provides a strong incentive to make honest promises and deliver results. Plus, dividends are real evidence of actual performance. Companies can fudge a lot of numbers, but a payout is a payout.
Next, dividends offer steady, real returns. They represent "a tangible return on investment that the market can't snatch away from you as it can a paper profit," writes Kelley Wright in his book "Dividends Still Don't Lie."
This means dividends will help you make up lost ground in a down or sideways market like the one we seem to be stuck with. That helps you build your retirement nest egg and also means you can sleep during volatile times like these, says David Abella, who manages the Rochdale Dividend & Income (RIMHX) fund. "Dividends make a world of difference in terms of investor psychology."
Finally, because a lot of investors gravitate to dividend-paying companies, dividends act as "an anchor for investor interest in a stock," says Abella. And high investor interest buoys prices.
3. Dividends offer an inflation hedge
This is one advantage stocks always have over bonds, the traditional cornerstone of an income-producing portfolio. A 10-year government bond will always offer the same payout. A company with a history of increasing dividends will likely continue to do so, providing protection against inflation.
Of course, the risk is that you can lose money owning a dividend-paying company if its stock sinks. But if you select carefully and stick to time-tested companies, share prices of the companies you pick aren't likely to stay down over the long haul, say five or 10 years.
So how do you plug dividends into your retirement accounts? Start with mutual funds.
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And Vanguard's 2% yield is nothing to get excited about. These days a 3% yield is the bare minimum I will accept and I generally only buy at 4% or above. Anything less than that and the dividend provides no price support at all.
In the end, my 401K will be mostly for Stable Value and bond funds. My Roth brokerage account will be for dividend equities. Hoping I can at least stay in the black.
Time is a number one factor. If the person is withdrawing for income, more than 1/3 the investment should be in a good income fund, all depending on amount invested. The remaining amount should be in several well-balanced funds. Withdrawals should be maid from the dividend/income fund, which should be replenished periodically from the other growing funds.
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