Increasing your passive income in retirement can have a significant impact on your level of financial freedom. However, achieving that goal has become increasingly difficult in recent years due in part to continued low interest rates.
Assets such as cash and bonds have offered disappointing returns on an after-inflation basis. With this situation likely to continue as monetary policy looks set to remain loose, now could be a good time to focus your capital on dividend stocks. In many cases, they offer a significantly higher return than other assets.
Through building a diverse portfolio of income shares, you could grow your passive income while managing the risks associated with investing in the stock market.
At the present time, buying dividend stocks instead of holding cash or bonds is likely to lead to a sudden and significant increase in your passive income. In many cases, dividend stocks offer a substantial real-terms return, which may not necessarily be possible through a savings account or through fixed-income securities.
Looking ahead, this situation could continue over the long run. Interest rates are likely to rise in the coming years, but ongoing risks to the global economy may mean that policymakers seek to tighten monetary policy at a relatively slow pace. This may mean that bond prices are supported, which will equate to lower yields. And, on an after-inflation basis, cash savings may struggle to offer a positive return.
By contrast, dividend shares could deliver rising shareholder payouts. In many cases, companies are enjoying robust operating conditions which may enable them to pay a higher level of dividends to their investors each year. As such, the passive income potential of dividend shares is greater than that of other income-producing assets at the present time, and could become even greater over the long run.
While it is tempting to simply buy a handful of the highest-yielding dividend stocks to maximise your passive income, diversifying is crucial in generating a sustainable passive income in retirement. It spreads the risk across a wide range of sectors and geographies, which could lead to a more robust income return. It may also provide exposure to sectors that could deliver a strong rate of growth, which leads to brisk increases in shareholder payouts.
Of course, dividend shares are inherently riskier investments than cash or bonds. The risk of loss can be reduced through diversification, but the prospect of a stock market downturn remains a threat. For any retirees, though, the difference in the return potential of dividend stocks compared to other assets could make them a risk worth taking. Furthermore, by focusing on high-quality businesses with a track record of stable dividends, you may be able to achieve a robust income return which offers greater financial freedom in older age.
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.