As Congress heads ever closer to the fiscal cliff, investors — and in particular, retirees — are keeping watch and scrambling to protect themselves.
For those who feel we’ll certainly fall off the cliff and suddenly become taxpayers of up to 39.5% of our dividend income in January, the “fight or flight” reflex will tilt toward the latter. And hopping out of a long-term dividend portfolio will be the likely action.
Investors who believe Congress will somehow avert going over the cliff through negotiation and compromise are probably — and rightly — resigned to be paying higher rates on their dividend income.
I have cautioned – indeed, almost pleaded — for retirees and investors not to panic and undo what might’ve been years, or decades, of building solid and diversified dividend portfolios simply out of fear. Ben Rooney at CNNMoney last week wrote an excellent article that backs up my position, saying “the prospect of higher taxes has not diminished the appeal of dividend paying stocks for many investors.”
Rooney finds agreement from several money managers, including Allianz Global Investors’ managing director and portfolio manager Ben Fischer, who told him: “I really don’t see any change in the argument that you have to come back eventually to high quality dividend-paying stocks that have the ability to raise their dividends over time.”
I agree completely with Fischer’s assertion. Sure, I understand that taxing dividends at anything above the current 15% level is going to hurt, and my fingers are crossed that the new rate will be between 20% and 25% (wishful thinking?). But at the end of the day, income is still income, and dividend stocks from established and profitable companies should remain a mainstay of any portfolio, particularly for investors close to retirement.
Investors should still be looking for (or keeping) companies that fit this bill. A great place to start is companies with dividend yields in what Rooney calls the “sweet spot” between 3% to 5%.
The 3% floor is just about enough (at least at this point) to beat inflation, and with yields for 10-year Treasury bonds around 1.65%, a dividend yield at 3% is a nice premium.
On the other end, stocks paying out at a 5% yield are typically running up against their ability to keep raising dividends in any meaningful way. Stocks paying out enough to warrant yields like Pitney Bowes (NYSE:PBI) — now around 13% — are traps, and best avoided.
To speed your search, here are three companies that land in that dividend-paying sweet spot — and for an even safer measure, trade at price-earnings ratios at or below 15x, a fairly conservative historical level.