Where does one find a decent return on an investment these days? For millions of Baby Boomers contemplating retirement, it's more than a rhetorical question.
A report by the Wall Street Journal shows the soon-to-retire generation, by and large, has not saved enough in their retirement accounts and has some catching up to do. Others who have put their money in certificates of deposit (CDs) are earning a paltry return.
Those whose investment has been wrapped up in their homes have seen values decline 30 percent or more. For Americans who have accumulated savings, the million-dollar question is where to invest it.
Get good advice
Before investing in anything, it is wise to consult a financial advisor who is completely objective. In other words, an advisor who does not sell an investment product but only offers financial advice for a fee. One question to ask them is about dividend-producing blue chip stocks.
Not all stocks pay a dividend, but many do. Paying a dividend is one way a company returns a portion of its profits directly to its shareholders. So, before a company can pay a dividend, it needs to be profitable.
While banks are paying a little more than one percent on CDs, blue chip companies like Johnson & Johnson, Campbell Soup, General Mills, Chevron, and Kimberly Clark, pay dividends of more than three percent. Altria, Eli Lilly, Bristol-Myers Squibb, AT&T and Verizon, pay dividends in excess of five percent.
That means if you invested $100,000 in a balanced, diversified portfolio of these high-yield stocks that yielded on average four percent, your money would earn $4000 a year in dividends, as long as the companies continued to pay those dividends. You would receive the dividends, usually paid quarterly, whether the price of the stock went up or down.
For funds in a tax-deferred retirement account, you might ask your financial advisor about master limited partnerships (MLP) that have issued common stock. MLP dividends tend to be even higher, and while the tax reporting requirements can make them a nuisance for small investors, there are no tax reporting requirements if the shares are owned by a retirement account.
Too high can be a turn off
That said, stocks that pay a very high dividend are often a red flag and should be avoided. It all depends on why the yield is high.
The dividend is based on the price of the stock. If a $10 stock pays a dividend of $1 per share, for example, that's a yield of 10 percent. But the question to pose is, can the company really afford to pay the dividend?
Let's assume the company set the dividend at $1 per share when the stock was trading at $50, a conservative yield of two percent. But if the stock price plunged from $50 to $10, the yield would shoot up to 10 percent.
The question you would have to ask, however, is why did the stock price plunge, and how much longer will the company be able to pay $1 per share.
Last year, before the Gulf oil spill, British Petroleum (BP) paid a dividend close to eight percent. However, in the wake of the oil spill, it eliminated its dividend entirely, since it was required to pay billions for the clean up.
And therein lies the risk with any kind of equity, including dividend-producing stocks. There is no guarantee that the dividend will continue, though most blue-chip companies have a long, stable history of paying out to shareholders. Still, it is a risk that must be carefully considered. The BP example shows that bad things can happen to the most rock-solid companies.
When looking at a company's dividend, compare it to the company's earnings per share. If the dividend is only half the earnings, that's a pretty good sign. If it isn't, you should ask yourself how the company can sustain that dividend.
However, before deciding where to invest your money, seek sound financial advice and do plenty of homework.