Relying on dividend stocks for a passive income in retirement may become an increasingly likely scenario for many people. Low interest rates mean income-producing assets, such as cash and bonds, may be unable to provide a sufficiently high income to cover living costs in older age.
Clearly, dividend stocks are riskier than many other mainstream assets. However, through holding some cash for emergencies and identifying high-quality businesses, it may be possible to rely on dividend shares for a passive income in older age.
The risks of holding dividend stocks
Dividend stocks experience price fluctuations like any other asset. However, capital returns may not be the main priority of retirees. They may be more focused on the level of income received from their portfolio. But this could prove to be unreliable due to the risks faced by the world economy.
For example, many income shares have decided to reduce or cancel their dividends. That’s been in response to the uncertain operating conditions they now face. A retiree who holds such companies will now experience a fall in their income in the short run. Although dividends may eventually return among those businesses that have delayed or cancelled them, there are no guarantees this will take place.
Therefore, relying on dividend stocks for a passive income is a riskier strategy compared to holding lower-risk assets such as bonds. There’s always a chance dividend cuts will negatively impact on your level of income.
Low relative returns
The problem facing retirees is that dividend stocks offer a far superior income return than other mainstream assets, in most cases. Low interest rates mean cash and investment-grade bonds may provide an insufficient level of income to fulfil your financial requirements.
Policymakers may attempt to support the economy’s recovery through a loose monetary policy. And that could mean the prospect of higher interest rates seems limited over the medium term.
Building a portfolio
Therefore, many retirees may find that they focus their capital on dividend stocks in order to generate a sufficient level of income. Should this be the case, buying a diverse range of businesses could help to lower your risks. It means you’re less reliant on a small number of companies to provide a passive income in older age.
Similarly, purchasing companies with defensive business models and sound finances could further strengthen your passive income prospects. They may be better equipped to survive an economic downturn. Therefore, they may also be less likely to reduce their dividend payments.
Investors may also wish to hold a sufficient amount of cash to provide them with support should dividend cuts be ahead. This may provide peace of mind. It also provides the financial resources to overcome the prospect of a challenging economic period. One that limits the capacity of income stocks to pay dividends for a period of time.