The dividends of retirement

I would say that maybe 99.99% of those saving for retirement shouldn't own stocks. Individual stocks, that is. Most people won't spend the time to truly educate themselves to understand P/E ratios, earnings growth expectations or to adhere to a sell discipline. But I do think everyone should own stocks but in a smart fashion through index funds. In particular the Vanguard S&P 500 Index Fund and the Vanguard Total Stock Market Index Fund. I don't care which one because they're are very closely correlated. But if you'd like to own the entire market choose the Total Market.

So why does the headline mention dividends? Because no matter what I say you'll still likely want to "play the market" and own a stock or two. If you're cautious and practical you'll likely favor stocks that pay dividends -- effectively you get a paycheck as a shareholder reward but still own the stock.

There's nothing magical about dividend-paying stocks. Because you own shares of the company your payout is a slice of the stock value. That is, when investors get a nickel it comes out of the market capitalization of the stock and the stock price usually falls to reflect this.

In the current low interest rate environment where it's hard to make one percent there are plenty of high quality stocks paying between three and five percent. The key here isn't getting a high dividend but one which is easily supported by the company's earnings. If the dividend yield (the dividend divided by the current price of the stock) is high that could be a warning sign that the dividend could be cut.

More on this topic tomorrow.