Laguna Niguel, CA
Thursday, September 27, 2012
In the current economic environment of generationally low interest rates, what previously served as conventional wisdom must be reexamined. Those interested in preserving their capital are essentially being paid less than the current rate of inflation on their savings. In other words, they are receiving a negative rate of return on their money. As interest rates increase, as they eventually must, the value of their fixed income instruments will decrease. Those in retirement are forced to either assume more risk in their investment decisions or to withdraw from their principal. In this environment, more investors are forced to consider allocating a lower portion of their savings in fixed income investments and more in stocks than they might have previously.
An investor's decision to commit funds to stock is based on his/her expectations for appreciation in the price of the stock and dividend income over his/here investment time horizon. While many investors concentrate on potential increases in the value of their stocks, they often underestimate the importance of dividends. In fact Dividends from stocks in the S&P were a key component of the returns that investors received from 1988 to 2005. Dividends provided 21 percent of those returns and their reinvestment provided another 47 percent. The importance of this cannot be overly stressed. True investors who are trying to achieve long term financial goals are doing themselves a disservice if they do not religiously reinvest any dividends they receive. Dividends can be invested either in the stock of the entity that paid the dividend or accumulated to invest in another company.
Guidelines for managing income from dividends are dependent upon whether one is in the wealth accumulation phase or in the wealth harvesting phase of his/her savings strategy. While one is building his/her nest egg, one should reinvest the dividends one receives from their investments. When one is harvesting the fruits of his/her investments, the guidelines become a little more complicated. The goal should be to use dividend income to support day to day needs for funds while allowing the principal to, ideally, continue to appreciate. If one is able to live off investment dividends and not harvest principal, it is highly likely that one would not outlive one's money. Therefore, one should stop reinvesting dividends produced by stocks held in taxable accounts. The rationale is simple. Since dividend income is taxed on such accounts irrespective of whether the dividends are reinvested, it would make sense to harvest this income first. Next, dividends generated in Roth IRA accounts, since they are not taxable, would be the next logical source of income. Last source of dividend income is that produced by stocks held in tax advantaged retirement accounts, IRA's 401 K's, etc. One should remember that all distributions from such accounts are taxable as regular income.
For further details on saving for retirement and managing one's finances refer to A Common Sense Approach to Successful Investing by Marvin H. Doniger.
About The Author
Marvin H. Doniger has been an avid investor since his early teens. During the course of his lifetime he has developed a philosophy that has served him in his own professional development and in the creation of an investment portfolio for his family's financial needs. His perspectives have been developed from his lifelong study of investing, his actual experiences as a registered representative, an individual investor, as well as from working for large companies in industry and as a management consultant to Fortune 500 companies.
He is the author of A Common Sense Road Map to Uncommon Wealth, which is a treatise on managing careers and finances, A Common Sense Approach to Successful Investing, in which he first introduced stratamentical analysis, a unique approach for identifying long-term investment opportunities, and Common Sense Prescriptions for Financial Health which presents quaestrology, a unique perspective on managing one's finances. He is also a regular guest on the Business Talk Radio Network and other radio shows. His articles have been published in media outlets such as Investor's Digest of Canada and Morningstar.
Mr. Doniger received a Masters in Business Administration from Columbia University Graduate School of Business and a Bachelor of Science Degree in Mechanical Engineering from Tufts University. He has taught undergraduate and graduate level courses in production control, inventory management, information technology and finance at Fitchburg State College and Webster University. He currently resides with his wife, Marsha, in Laguna, California.
Marvin H. Doniger
Laguna Niguel, CA