Coca Cola is certainly an exemplary company to demonstrate the power of dividends, but its returns are hardly extraordinary. Dividend stocks like Coca Cola have historically outperformed non-dividend-paying stocks. Why? Because dividends are typically paid by larger, more stable and financially competent businesses. And it should come as no surprise that dividends tend to dampen volatility, at least as measured by standard deviation of stock price changes.
Manageable Risk
And volatility is only one measure of risk. The true risk of a stock lies in its potential to permanently lose part or all of its value. Dividend-paying blue chip companies have shown they have the experience and stability to weather financial hard times and retain their value over the long term. While other companies might pursue unwise acquisitions, fund excessive expansions of capacity, or devise obscene management compensation packages, only the most disciplined and prudent companies will be able to pass along large dividends to shareholders.
The ability of a company to pay dividends is a signal of strength and security that should come across as a welcome attribute to retirement-aged investors looking to avoid excessive risk taking while still earning meaningful gains.
That's not to say, of course, that dividend stocks are risk free. Risk is an unavoidable aspect of any stock portfolio, and for many retirement-aged individuals this inevitability is enough to make stocks of any kind an intimidating and unappealing asset class.
The obvious drawback to relying on dividends as a source of income is there is no guarantee that they will be paid in any given year. If a company needs to retain its earnings to pursue ventures or stave off financial distress, its Board of Directors is free to not declare its usual dividend. I would suggest that in terms of the long-term growth and stability of a portfolio, this option is not necessarily a bad thing, as it provides companies with cash when they most need it. But I also recognize that for investors minding short-term performance and retirement income, the uncertainty regarding dividend payouts is a serious one.
And there's always the risk of a falling stock market, the uncertainty of which is no less serious. But, at this hour, we do at least have history on our side. Specifically, the stock market is entering a decade following a 10-year period of negative returns. There have been thirteen such 10-year periods since 1871 and the returns of the subsequent 10-year periods following these decades been over 10% on average, far exceeding the average annual return of 6.66% for all 10-year periods. While there's no guarantee this decade will stay true to history, there's no reason to think it will be any different either.
Best Of Both Worlds?
In the end, retirement-aged investors--like all investors--must remind themselves that no risk equals no return. As the Social Security system strains and pension plans dwindle, prospective retirees are going to have to rely more on personal savings, and that means tolerating some level of risk in order to make ends meet. High-dividend-paying stocks offer the most manageable levels of risk and the greatest value to investors reaching retirement. An expertly managed portfolio of dividend stocks can provide the income of bonds along with growth potential without sacrificing security.
I believe that investors who take the lead in this migration will be rewarded with both income and capital gain well beyond what is available from cash and other alternatives, without subjecting themselves to outsized risk. The retirement-aged investor will then have a far better chance of maintaining a standard of living while preserving purchasing power for future years, and the more aggressive investor will improve the probability of achieving the consistent compounding of his or her wealth.
Michael Golub is the founder of The Golub Group, a California-based investment firm offering institutional-grade investment management to high net worth individuals, investment advisors, foundations, and select institutional investors. For more information on The Golub Group, or to receive a copy of Dividend-Paying Stocks: The Solution to the Retirement-Aged Investor's Dilemma, please click here.