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By Josh Peters, CFA and Jeremy Glaser | 01-26-2016 04:00 PM

Retirees: Key Factors for Picking Dividend-Payers

The income stream from dividend-payers can play a special role in funding portfolio withdrawals, but they are no substitute for bonds, says Morningstar's Josh Peters.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. What are some of the key factors that retirees should consider if they're thinking about dividend-paying stocks? I'm here with Josh Peters, the editor of our DividendInvestor newsletter and also the director of equity-income strategy at Morningstar for his thoughts.

Josh, thanks for joining to me.

Josh Peters: Good to be here, Jeremy.

Glaser: First off, why should retirees potentially consider dividend-paying stocks as part of their portfolios?

Peters: Your typical retiree is going to be looking for income one way or another, and the most direct way you do that is by funding a portfolio withdrawal. You're going to take out probably some fixed dollar amount over the course of each year, and then with inflation you would expect to take out a little bit more year after year. There are a lot of different ways of trying to meet that withdrawal, and a lot of investors and their advisors are totally agnostic toward dividends--some are even hostile toward dividends--because total return is the bottom line. And that's not just income; it's capital appreciation or capital losses combined over time. That's really what you need.

But income does play a very special role in being able to fund portfolio withdrawals during retirement without being forced to sell shares. The last time in the market cycle that you want to be a forced seller to meet your living expenses is right at the bottom. But if you're able to pick stocks whose dividends aren't being cut at the bottom of a recession or a bear market, then the stock may be down but the yield automatically has gone up on a spot basis to compensate; you've got dividend income to help you fund that withdrawal.

In addition to that, dividend-paying stocks, high-yield stocks, have had a long history of outperforming broad market indexes and companies with no dividends. They also tend to be more defensive in nature. They're easier to own in more volatile markets. But just the practical value of the income as part of the total return stream is really valuable for retirees as well as people who are still in the accumulation mode.

Glaser: What's the best way to evaluate a stock for its dividend-paying potential? Are you just looking for the highest yield today? Is it all about growth? How do you balance that?

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