Before deciding which investments are best for you, you should look closely at the new tax law, which lowered the rate you pay on dividends and capital gains to 15%. This law has provided investors with some really significant opportunities to improve their wealth.
Whereas many investors might have previously favored investing in bonds to meet their income needs, our research shows that most investors would be served far better by investing in certain types of dividend-paying stocks.
Consider these facts …
1. Bond interest is taxed at a higher (ordinary) federal tax rate than dividends, so you give up more of the money your investments produce when you buy bonds.
2. Dividend-paying companies frequently increase the amount of dividends they pay, while bond interest is never increased. Effectively, with the right dividend-paying stocks, you can get a �raise� each year of retirement.
3. With bonds, your strategy should always be to hold to maturity, because they are too expensive to buy and then sell. In any case, you face the possibility that you will be left holding bonds paying lower interest at a time when rates are rising. No such lock-in period exists with dividends, leaving you with more flexibility.
4. When interest rates decline (when the economy slows down), bonds which were issued at higher interest rates when the economy was booming are �called� (paid off), leaving you with the problem of reinvesting at lower rates, effectively taking a �pay cut.� Dividends are usually left unchanged during these same events.
Because of the differences in tax rates and considering the effect of normal dividend increases, our research shows that an investor can end up with significantly more money by investing in high-dividend stocks rather than bonds over a 20-year period. As Table 1 shows, an investor that buys a stock paying a 3% dividend and appreciating 3% a year will end up with 28% more money than an investor who buys a bond paying 6% a year. Even though the total returns are the same � 6% in each case � the dividend investor comes out ahead simply due to the difference in tax treatment of the two types of investments. If the stock�s dividend is also increasing by 3% a year, as shown in Table 2, then the investor ends up with 55% more after 20 years.
Investors should understand the financial advantages and risks of a portfolio of secure, high-dividend-paying stocks before committing their investment dollars. Our work with retirees over the last 15 years has shown that most people who are retiring today simply cannot afford the lifestyles they want if a significant portion of their investments is in bonds.
Having an advisor who can structure and maintain your investments properly will go a long way toward making your retirement what you desire.