Already looking at portfolio losses of 30% and more, retirees are losing dividend income as companies try to weather the recession. The financial meltdown has hurt dividends of financial stocks which are 16 percent of the S&P 500's value and contribute 26 percent of dividends. The number two sector for dividends, consumer stocks, pays just half that much. According to S&P, 25 financial companies have reduced dividend payments since the fourth quarter of last year, compared with seven in the previous five years. Dividend cuts are on track for the worst year since 1958 when dividends payments fell by 8.4%.
Investors face the possibility of paying higher taxes on dividends they did receive, thanks to tax laws. Firms that lost money are exempt from Federal income taxes. Hence, the dividends paid to investors by these firms will be treated as ordinary income instead of capital gains, pushing the tax rate to 35% from 15%.
The reduction or elimination of dividends is an admission by corporations that their business model is under pressure. It means less money going into investors’ pockets and into the overall economy. It also means alienating investors who generally hold dividend paying stocks for the long-term income stream.
Treasury Notes
For an income-generating portfolio, consider investing in investment grade bonds. Treasuries first come to mind, but the recent flight-to-quality has pushed yields on the 10-year note to 2.55%, levels not seen since 1955. As treasury rates rise, prices will decline, hurting investors who choose not to hold treasuries to maturity.
Corporate Bonds
Investment grade 10-year corporate bonds are yielding 4.4%, better than the 2.87% average dividend yield for all S&P 500 stocks. Suitable for the long-term, investors will get their principal back when the bond matures, while enjoying semi-annual income payments. Default rates on corporate bonds are low, not topping 1.6% since 1929. In the event of bankruptcy, creditors such as bond holders stand in line ahead of stockholders.
Municipal Bonds
Investment grade municipal 10-year notes are yielding 3.14%, with tax-free treatment of income generated. A taxable 10-year investment would have to return more than 3.69% to be profitable. Stick with general obligation bonds or revenue bonds from larger, more diverse and credit worthy municipalities with a track record of repaying past obligations.
Individual Bonds or Mutual Funds
Investors with less than $50,000 to invest should stick to mutual funds for the diversification they offer. Note that all bond funds are tied to the day-to-day price movements of their holdings and may be too volatile for some investors. For those choosing to go it alone, individual bond issues should be researched diligently, taking note of credit ratings, maturity and call provisions, if any.
