Jobs You Might Like

3 Steps to Stay Afloat in Tough Times

You can get more from your savings — despite interest rates at record lows

by: Carla Fried, from: AARP The Magazine, January 31, 2012

Cash and bonds provide stability, whereas stocks offer the potential for inflation-beating gains over the long term. One trick is to make your stock portfolio pull double duty and give you an income stream today, by building it around stocks that pay dividends — income payouts that corporations make to shareholders.

Join AARP today – Receive access to exclusive information, benefits and discounts.

Let’s say a company’s stock sells for $25 a share and pays an annual dividend of $1. That means for every share you buy at $25 you will get an annual income payout equal to 4 percent. If you already own a broad stock market index in your 401(k), you are getting some dividend income; the yield on the S&P 500 is about 2 percent these days.

You can get more dividend income by focusing on a portfolio that specializes in dividend payers.

All of this should offer some pretty good ammunition for savers who are ready to fight back.

Carla Fried has written for Money and The New York Times.

You may also like: The pros and cons of credit unions.

Not All Dividends Are Equal

Focusing your stock portfolio on companies that pay dividends can be a smart move. You can collect dividends and use them for current living expenses, or reinvest them in more shares, thereby enhancing the total return of your investment. But it’s important to understand that deriving income from stocks is quite different than from bonds.

Stock dividends aren’t guaranteed. Companies can stop paying or reduce the amount if they hit tough times.

Case in point: In 2009 more than 800 companies cut payouts by a cumulative $58 billion, with much of the carnage coming from banks. A U.S. Treasury bond, in comparison, never cuts its payout.

Your workaround: Opt for mutual funds and Exchange-Traded Funds that own a broad diversified portfolio of dividend payers from different segments of the economy. For example, the Vanguard 500 Index Fund (VFINX; dividend yield: 2.03 percent) invests in the stocks of 500 companies, and the SPDR Dividend ETF (SDY; dividend yield: 3.2 percent) currently invests in 60 stocks. That’s far safer than owning just a handful of stocks.

Dividend payers aren’t bear-proof. A 3 to 5 percent dividend payout won’t eliminate the pain of a bear market but can soften it. In 2008, for example, companies in the S&P 500 stock index that paid a dividend lost 39 percent of their value. But nondividend payers did even worse: They lost 45 percent.

Your workaround: Remember that stocks are stocks and bonds are bonds. You should have an age-appropriate mix of both, and then stick with the plan, no matter what the market or the economy is doing. Even solid dividend payers can slump, so you never want to sell bonds to load up on dividend stocks.

—C.F.