The Case for Dividend Funds in Retirement

An Allocation to High-Paying Shares Can Help Preserve Retirement Capital

It's OK to spend your income, but never, ever dip into capital.

Remember that old financial commandment? It was discarded long ago as a fuddy-duddy rule that doesn't work in our low-yield world. But as I ponder retirement, focusing on dividend-paying stocks, so you don't have to dip so often into capital, looks better and better— for seven reasons.

Low bond yields. While stocks aren't cheap, bonds frighten me more. The 10-year Treasury yields about 2.6%, almost double its 2012 bottom but still historically low. There isn't much room for interest rates to fall, and they could rise sharply, especially as the Federal Reserve scales back its bond purchases. If rates climb, bondholders could suffer painful declines in their portfolio's value.

Less risk. Instead of investing for dividends, investors have been encouraged in recent decades to create their own dividends by occasionally selling shares. But recall those two huge bear markets we've had over the past 14 years. If you needed to create your own dividends, you could have found yourself selling stocks at deeply depressed prices.

By contrast, dividends aren't nearly as volatile as share prices, though they too have had some notable declines. Five years ago, as the Great Recession took its toll, the S&P 500 companies slashed their dividends by 24%. It was particularly grim during the Great Depression, when dividends were cut 47%, even after adjusting for that period's deflation. In both instances, however, the decline in dividends wasn't nearly as severe as the decline in share prices.

Still, those severe cuts suggest that, even if you could afford to live solely off your portfolio's dividend yield, you need a safety net. One possibility: You might combine investing for dividends with, say, a cash reserve that you could draw on when economic crises hit and dividends get scaled back.

Inflation protection. Over the long haul, dividends have handily outpaced inflation, potentially providing retirees with a growing stream of income. Consider some numbers based on data from the website of Yale University economics professor Robert Shiller.

Over the past 100 years, the dividends from a diversified collection of U.S. stocks would have grown an average of 4.4% a year, easily outpacing the 3.2% average inflation rate. Even as you collected your dividends, your shares would have been climbing in value, notching price gains averaging 5.6% a year.

Intriguing funds. Unless you have a huge portfolio, you would find it tough to live off the S&P 500's 2% yield. But what if you bought high-dividend stock funds? For instance, among exchange-traded index funds, you can currently collect yields of around 3% from iShares High Dividend ETF (HDV), Vanguard High Dividend Yield ETF (VYM) and WisdomTree Equity Income Fund (DHS).

For further diversification, you might add foreign stocks. Check out funds such as iShares International Select Dividend ETF (IDV) and WisdomTree DEFA Equity Income Fund (DTH).

Favorable tax treatment. While interest from bonds is taxed as ordinary income, qualifying dividends are taxed at the long-term capital-gains rate. For everybody except those in the top federal income-tax bracket, that will mean paying 15% or less. One caveat: While dividends from most blue-chip U.S. stocks should qualify for this tax treatment, you may find that dividends from some U.S. stocks and foreign shares are taxed as ordinary income.

Value effect. Research suggests that bargain-priced value stocks have, over the long haul, outperformed fast-expanding growth stocks. High-dividend stocks are usually value stocks, so they could perform better than average if the value effect persists.

More discipline. In recent years, companies have eschewed dividend increases in favor of stock buybacks. But companies are quick to halt buyback programs when their finances get tight, whereas they're loath to cut dividends. Indeed, paying a large, regular dividend provides managers with a healthy dose of discipline and forces them to think more carefully about how they spend the company's remaining cash.

This isn't to say you should bet your retirement solely on high-dividend stocks. The financial world is too uncertain for that. But tilting toward high-dividend stocks deserves a place alongside other retirement-income strategies, including delaying Social Security, annuitizing a portion of your savings and holding a hefty cash reserve.

If you're collecting 3% in dividends and your goal is the often-recommended 4% portfolio withdrawal rate, you will need to augment your retirement income by dipping a little into capital and doing some occasional selling. But thanks to the dividends, you won't have to do much selling—which means you can watch those stock-market swings with far greater equanimity, while you wait for your next dividend check to arrive.


Keith Brainard
Keith Brainard subscriber

Great to have Jonathan Clements back. Sound, timeless advice. No market timing, no hunting for the next big winner, no hype. Just good advice.

Tim Dolan
Tim Dolan subscriber

Welcome back Mr. Clements. I have certainly missed your Getting Started Column. I will be looking forward to whatever you have to say. Regards, Tim Dolan...

Dom Fried
Dom Fried subscriber

ESV is at 6% and NE is almost 5%. Both are near lows right now and cap ex will decrease as they finish their fleet conversions over a few years. Oil can be volatile but maybe I'll leave those shares to the kids.

gabriel russo
gabriel russo subscriber

Remember, in the end, we are all dead!

Dennis Bell
Dennis Bell user

"If rates climb, bondholders could suffer painful declines in their portfolio's value."

Not if the bonds are held to maturity. Clements, like most financial scribblers, always assumes bondholders are traders.

Gary J. Rhine
Gary J. Rhine subscriber

I never got the whole 4% portfolio withdrawal rate thing unless you plan on leaving a bunch of money in the end. If you intend to spend it all in your lifetime you actually need a higher withdrawal rate given all but the most conservative of portfolio returns. And if you have never taken much risk you probably don't have much in the first place.

John Beauregard
John Beauregard subscriber

"While dividends from most blue-chip U.S. stocks should qualify for this [qualified dividend] tax treatment, you may find that dividends from some U.S. stocks and foreign shares are taxed as ordinary income."

...and you might be facing that nasty Form 1116, for which I believe the tipping point is $600 in foreign-sourced dividends.

JOHN HAUSER profilePrivateuser

Great to have you back Jonathan!

"Remember that old financial commandment?" is not a commandment and never should be. In fact, retirees should concern themselves with total return. Dipping into capital is not a crime. In fact that's exactly what we should be doing. After all, retirement assets are meant to be spent in retirement.

High dividend and dividend growth strategies are just another form of market timing and sector selection (bias) and will end badly. The asset will become (or already is) overvalued and future total returns will suffer as they fall back to the mean (average).

Better to decide on an appropriate split between stocks and bonds implemented with a short list of broadly based index funds.


Bruce Fernandes
Bruce Fernandes subscriber

MLPs have been increasing their distributions by 6-10% each of the last five years. The misinformation campaign by the wall street money machine has kept investors from investing in MLPs in their retirement account. I have had net negative UBTI each of the last five years and now my distribution yield to cost on almost all of my retirement MLPs is in the double-digits and growing each quarter.

Funny how these articles NEVER consider other asset classes that have far outperformed S&P 500 dividend payers.

Scott Marshall
Scott Marshall user

buy tobacco stocks, never sell. retire off the lavish divs.

Jacob Schroeder
Jacob Schroeder subscriber


Glad to have you back. Your knowledge and writing style are inspirational to other writers like myself in the financial services.

While I think dividends are important to an investor, trying to rely on them seems to be a risky strategy. First, when a company declares a dividend, the stock of that company drops by that amount since it is paid out of its coffers. So, essentially, the investor is still taping into their principal if they spend that dividend.

Additionally, relying on dividends means putting your income in the hands of corporations to decide when they distribute the money and by how much.

And, what about diversification? Only about 40% of the Wilshire 5000 pays dividends, so filling your portfolio with dividend-paying stocks potentially eliminates 60% U.S. stocks from your consideration.

Would it not be better for investors to create a total portfolio and simply reinvest dividends in broadly diversified funds to help grow or sustain it, then take income from the total return?

Look forward to next Sunday.

Thomas Farrelly
Thomas Farrelly subscriber

Bruce, thanks for responding to my request for comments.

Mitch Conover
Mitch Conover subscriber

It is not that simple. You have a sample size of 1 from anecdotal experience. You need more than 5 years of data to make a case for MLPs. If you have it, I'd be happy to read it though.

It is good to see Jonathan back at the WSJ.

Charleen Larson
Charleen Larson subscriber

I don't think Mr. Clements was suggesting one should rely on dividends.

Bruce Fernandes
Bruce Fernandes subscriber

I'm sorry if I wasn't clear I have owned MLPs in my IRA since 3/09. I have five years and many more to go because the energy infrastructure growth story has another 20 years of play left in it. I own best of breed pipeline and gathering/processing (G&P) MLPs in my IRA all of which get a significant majority of their income from fixed fee contracts versus higher risk commodity price type contracts. My portfolio is weighted toward MLPs that acquired their GPs and eliminated IDRs. EPD, MMP, GEL, and MWE specific to the elimination of GPs and IDRs. PAA, NGLS, ACMP, ENLK (formerly Croisstex LP) that are faster growing MLPs that still have GPs... and TRGP, ETE, and ENLC (formerly Crosstex GP) in the GP space.

Charles Schwab prepares my Form 990T and for five years now I have had negative UBTI.

My yield to cost in MLPs is all double-digits now. My yield to FMV is 4.62% meaning a comfortable 4% income only distribution from my IRA when I start taking distributions.

My MLPs are growing distributions 6-9%/year on average with a few outliers like MMP and ACMP growing at much higher rates in the MLP space and the three GPs growing their dividends at almost 20%/year on average.

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