How dividend-paying stocks fit into retiree portfolios

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Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar.com. One side effect of the pandemic in the financial markets is that some companies have been forced to cut their dividends or eliminate them entirely. So where does that leave retirees who may be relying on dividend stocks for some of their income? Joining me today to discuss that topic is Christine Benz. Christine is our director of personal finance at Morningstar.

Christine, thank you for joining us today.

Christine Benz: Susan. It's my pleasure.

Dziubinski: Now let's start with the news. So can you talk a little bit about why these dividend cuts and eliminations have been happening?

Benz: Well, of course, we've seen this huge contraction in terms of GDP growth. So companies are feeling pressure on their profitability. They're feeling pressure to conserve cash and also to conserve employees. They want to try to keep as many employees on the rolls as possible.

So those things have forced many companies to cut their dividends. By some estimates, we've seen more dividend cuts so far in 2020 than we had since 2001. So the dividend cuts have been widespread, and they have affected companies in lots of different industries.

Dziubinski: And have there been particular pockets of the market or industries where these cuts have been more concentrated?

Benz: Definitely. The energy sector, as you might expect, has come under pressure. We've seen a lot of dividend cuts there. Of course, with the economy way down, with economic activity way down, so is fuel consumption. Naturally those companies have been feeling pressured. They've been under pressure for some time due to declining energy prices.

Then we've also seen a lot of dividend cuts in the consumer discretionary space. So that encompasses the travel and leisure companies, which have of course been quite hard-hit. It also encompasses some of the retailers, which have historically paid dividends. Many of the big retailers are scaling back their dividends in the face of this crisis.

Dziubinski: Now these dividend cuts are of course a risk for retirees because that interferes with some income that they may be relying on, and they're also coming at a very difficult time.

Benz: Well, they are because we've seen yields decline on high-quality bonds as well. So it's a kind of bad convergence that we also saw during the great financial crisis where we saw, in that case, banks--which had historically been major sources of dividends for many retirees--we saw bank slash their dividends at the same time the Fed was working to keep interest rates low. So that combination is one we've seen before, and it tends to be particularly difficult for income-centric retirees.

Dziubinski: Do you think dividend-paying stocks still play a role in retiree portfolios today?

Benz: I think they absolutely do, and there are a couple of reasons why. One is if you look at current yields on high-quality bonds and certainly cash, they're very, very low today. Raw materials for decent returns from those securities just aren't there, given that current yields have historically been a pretty good predictor of what you might expect from those asset classes.

Then the other reason is that, in addition to the growth that investors can get from equities, if they are long-term holders of equities, one thing we know by examining market history is that dividends have historically composed a huge share of the market's return over time.

So you need stocks because you need growth and you also need dividend-paying stocks because they've contributed such a big percentage of that growth over time.

Dziubinski: How would you then suggest that retirees be thinking about incorporating dividend-paying stocks in their portfolios today?

Benz: Do it in a really balanced way. They might pair high-dividend-yielding stocks with dividend-growth companies, which may have less impressive yields but have better growth prospects.

You might pair, say, a high dividend yield ETF or mutual fund with one with a dividend-growth focus to give yourself a little bit of balance there. And certainly also looking at the asset-class exposures within your portfolio, looking for, again, some type of balance across high-quality bonds, as well as dividend-paying stocks.

Then finally, I think that retirees really would benefit from thinking expansively about cash flow as opposed to being very focused on current income. Of course, we all like getting income from our portfolios, but I like the idea of entering retirement with the idea of being flexible about where you'll source your cash flows.

So when yields are higher, maybe your yields will provide all of your cash flow needs and then some. In markets like the current one, maybe cash is the asset class that you draw upon because it's not a great time necessarily to draw upon equities. And then in great equity market environments, selling appreciated equities may be your cash flow source.

My thought is to be flexible, to be a little bit eclectic when it comes to sourcing cash flow production in retirement. I think ultimately that will lend itself to a more stable portfolio construct.

Dziubinski: Well, we know this is a very important topic to retirees, so we really appreciate your time discussing this today with us, Christine.

Benz: Thank you so much, Susan.

Dziubinski: I'm Susan Dziubinski for Morningstar.com. Thank you for tuning in.

This report appeared on www.morningstar.com.au 2021 Morningstar Australasia Pty Limited

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