In a world where markets are hitting new highs–which makes return expectations uncertain going forward–getting income is more important than ever. It’s one of the reasons why I personally insist on a dividend from every investment I buy today. Capital gains are no guarantee.
Many retirees are in the position of having to live off their dividends. This can be a highly effective strategy provided the portfolio is diverse and the investor doesn’t go chasing yield. A 10% dividend is great if the company can continue paying it.
So these folks stick to stocks paying 3% or maybe 4%, knowing that dividend growth will help make up the difference. It’s a solid strategy that has been proven to work over the long term.
There’s just one problem: most would like a little more income today to pay for things like more vacations, a golf membership, or to spoil the grandkids.
We can help. Here are three ways investors can extract more income from their dividends.
Many companies offer dividend-reinvestment plans (DRIPs), which give investors a bonus for taking their dividends in the form of more shares rather than in cash.
This benefits the company because management then has more cash at their disposal to use for acquisitions, expansion, or a million other things. Ultimately, it leads to less debt.
Let’s look at a real-life example of how DRIPs work. Shareholders in Altagas Ltd. (TSX:ALA) already enjoy a generous 6.2% yield–one of the best payouts offered by a TSX Composite member company today. And best of all, the distribution is sustainable, coming in under 80% of funds from operations.
An Altagas shareholder who opts to take their dividends in the form of more shares would get a 3% bonus for doing so. Thus, the dividend increases from 6.2% to 6.4%.
All an investor would have to do to access this increased income is to sell the newly acquired shares. But ideally, they’d just continue to hold, further increasing the compounding effect.
Sprinkle in a little risk
The Altagas example is perfect to illustrate my next point. It’s okay to add a little risk to supercharge your income.
Many investors have a simple rule of thumb. If a stock yields over 5%, they won’t buy it. The market perceives it as risky; therefore, the payout has a high chance of getting cut.
Nothing could be further from the truth. There are a number of things that could cause a company to have a high yield. It might be a low-growth company, paying most of its profits out to shareholders. Or it could be suffering from temporary problems–fixable short-term issues.
Whatever the reason, it’s not that hard for investors to protect themselves against the risk of one high-yield company blowing up. All they need to do is spread the risk among a number of different stocks. One stock yielding 7% could be very risky. A dozen stocks are far less so.
Preferred shares often offer investors a higher current income with better safety. The trade-off is that preferred shares will never hike their distributions and will offer very poor capital gain prospects. The asset class as a whole is more like bonds than stocks, but most do pay dividends rather than interest.
Sometimes the gap between a preferred share dividend and a common share dividend is massive.
Take George Weston Limited (TSX:WN) as an example. The common shares pay a paltry 1.6% dividend yield, which is about average for the retail sector. The company’s preferred shares are much more attractive to the income seeker.
The Series V preferred shares (which trade under the ticker symbol TSX:WN.PR.E) currently offer a yield of 5.4%. Sure, the preferred shares don’t come with any dividend-growth potential, but it takes a very long time for a 1.6% yield to grow into a 5.4% one.
The bottom line
Retirees don’t have to be resigned to collecting anemic yields. All they need to do is examine other options like DRIPs, preferred shares, and dedicating a small part of their portfolio to so-called riskier stocks with better payouts.
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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Nelson Smith owns George Weston preferred shares. Altagas is a recommendation of Stock Advisor Canada.