“I’m not concerned about a return on my money; I’m concerned about a return of my money.” ~Mark Twain comment made famous by Will Rogers.
During our lives, the difference between “wants” and “needs” evolves. Those of us born between 1946 and 1964, often referred to as Baby Boomers, have seen priorities shift in response to our own aging process and technological advancements. Many things that used to be “wants” are now “needs.” Economic output and personal cash flow management vary in response to these transitions.
While at a conference on investment trends, examples of these modifications were discussed, including these findings; fifty-one percent of baby boomers believe that pet care is a basic need; eighty-four percent feel that internet connection is necessary, annual vacations are a requirement, and not surprisingly, ninety-eight percent believe that health care is an essential priority.
With the advent of new medical technology and equipment, the “needs” for life saving items such as sleep apnea machines and various prescription medications expand. The result is that many of us are living long and should plan accordingly for our cash flow requirements. No one wants to outlive his or her money.
Technology has also provided new ways to save money. One in five smart phone owners use mobile coupons, a concept that has emerged in response to the widespread use of cell phones. Since the recession began, overall coupon usage has grown at a fast clip, up over 26.7% according to one source. It’s obvious that consumers are interested in saving money; telecommunications and internet access are increasingly important to how business operates in many ways.
In the investment world, coupons are associated with bonds and dividends are related to stocks. As we watch “wants” turn into “needs,” investors have to be more creative, and careful with their cash flow management. The Federal Reserve pledged to keep interest rates low until 2015 so many traditional income sources are not generating much in the way of returns.
This has driven up the prices of high-dividend paying stocks, lowering their yields and inciting talk of a dividend bubble. That may be overstating matters, but it could be time to step back and think about the different ways to generate income from the equity portion of a portfolio.
There’s an old saying that investors need to be concerned not just about return on capital but also about return of capital. In this respect, investors seeking dividend income should consider how much a company is currently paying, whether it will be able to continue to do so, and contemplate the likelihood of an increase of its dividend in the future.
While there’s no way to be certain that a given company will be able to continue paying its dividend, it is possible to get some idea of how sustainable a dividend may be by looking at what’s called the payout ratio. This is simply the percentage of the company’s earnings it is paying out in dividends. For example, a company with $500 million in net income that is paying out $250 million in dividends has a payout ratio of 50%. For an even closer look, instead of examining only earnings, determine the company’s cash flow from operations (this can be found in the 10-K document that public companies file each year) and divide that by the amount of dividends paid.
While there’s no hard and fast rule, rapidly rising payout ratios may indicate that a company’s ability to cover or pay its dividend is diminishing. As with many things in the market, you want balance, which translates into a payout ratio high enough to show that the company is committed to returning a substantial amount of earnings to shareholders, but not so high as to endanger its ability to maintain the dividend.
Stocks that consistently grow their dividends may provide protection against market volatility. When we look at the performance of stocks over lengthy periods that include economic contractions and expansions, dividends play an impressive role. For example, over the past 20 years, dividends have accounted for approximately one-third of the total return of the S&P 500 index.
It’s important to remember that dividend payouts are not guaranteed. Companies can reduce or eliminate their dividends, and many did so in the recent recession. This makes thorough investigation a must. While no one knows what the markets will do in the future, dividend- paying stocks historically have been kind to investors. Stay focused and invest accordingly.
The S&P 500 is an unmanaged index of 500 widely held stocks. Past performance is not indicative of future results. This information is general in nature, it is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or solicitation to buy or sell any particular investment. Investing involves risk, and investors may incur a profit or a loss. There is no guarantee any particular investment strategy will be successful. Opinions expressed herein are those of the author and subject to change at any time.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and federally registered CFP (with flame logo), which it awards to individuals who successfully complete initial and ongoing certification requirements. Diversification and strategic asset allocation do not ensure a profit or protect against a loss.
Darcie Guerin, CFP®, is Associate Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email firstname.lastname@example.org. www.raymondjames.com/Darcie