My Mother’s Love Affair With Dividends
My mom is far from rich…
But she and my late father were diligent savers and accumulated a modest nest egg that my mother uses to supplement my parents’ pension and Social Security.
However, the persistent decline in interest rates has cut the amount of interest she earned on that nest egg by more than 80% over the years.
My mother is far from alone. There are tens of millions of retirees in the same low interest rate boat. This makes it all the tougher on conservative investors to make ends meet these days.
Worse yet, the already low interest rates are likely only going to get lower when the Federal Reserve meets tomorrow.
The Fed is widely expected to cut interest rates. And most likely will again later on this year.
What’s an income-focused investor supposed to do?
I will give you the same advice that I gave my mom… Load up on conservative, dividend-paying blue chip stocks.
Here are four reasons why…
Reason #1: Stocks and Bonds Pay the Same. The dividend yield of blue chip stocks in the S&P 500 is 1.9%; that’s about the same as the yield on the 10-year Treasury bond, at 2%. But dividends offer a big advantage over bond yields: They grow over time.
Reason #2: Dividends Grow. The S&P 500 may pay a little less than a 2% dividend today, but that payout is going to increase over time. And last year alone, S&P 500 companies increased their dividends by 7.8%, and thanks to the Trump tax cuts, 2019 is shaping up to be an even better year for dividend investors.
In fact, over the past 10 years, S&P 500 dividends have grown an average of 9% a year! That means a 2% dividend yield should double to 4% per year in about eight years, and then double again to 8% about 16 years from now and so on!
Meanwhile, a Treasury bond with a 2% yield purchased today will still only offer you just 2% 10 years from now.
Reason #3: Half the Tax! The 2017 Tax Cuts and Jobs Act. Aka the Trump tax cuts, the new laws had very little effect on dividend taxation and (qualified) dividends are still taxed at a much lower rate than bonds and CDs.
The rate at which qualified dividends are taxed depends on the income of the recipient.
For 2018, qualified dividends are subject to a 0% tax rate for taxable income up to $38,600 for single filers and $77,200 for joint filers. You heard me: zero, zilch, zip, nada.
If you’re in the $38,601–425,800 ($77,201–479,000 joint) tax brackets, your dividends will be taxed at a maximum 15% rate.
And if you are in the $425,801 and higher ($479,001 joint) tax bracket, your dividend income will be taxed at a maximum of 20%.
What is a “qualified dividend”?
Qualified dividends are those paid by domestic or qualifying foreign companies that have been held for at least 61 days out of the 121-day period beginning 60 days prior to the ex-dividend date.
Traditional fixed-income investments — bonds, CDs, money markets and Treasuries — are taxed at ordinary income rates, which means as high as 37%.
I don’t care how you slice it, the 0%, 15%, and 20% tax rates on dividends beat the heck out of a 37% tax rate on interest income. And that is why dividend-paying stocks should be the foundation of any income-focused portfolio.
The final reason to invest in dividend stocks is…
Reason #4: Safer Than You May Think. Dividend-paying stocks have historically been much less volatile than the overall stock market. Take a look at the beta of three popular dividend-focused ETFs:
- 77 beta: iShares Core High Dividend ETF (HDV)
- 83 beta: iShares Select Dividend ETF (DVY)
- 83 beta: SPDR S&P Dividend ETF (SDY).
A beta of 1.0 means that an ETF will move up and down in lockstep with the S&P 500. But an ETF with a beta of 0.77, for example, is 23% less volatile than the S&P 500.
In short, the lower the beta, the lower the risk and that is why dividend-paying stocks offer some effective defense during difficult markets.
So what are you waiting for? Join my mother and jump on the dividend bandwagon!
Here’s to growing your wealth,
Chief Income Expert, Mike Burnick’s Wealth Watch