Tell me about safer investments

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Q: The market decline is bothering me, so I have been looking for safer places to invest. I’ve read a lot about stocks and funds that pay dividends. Should I focus on companies that pay dividends?

A: Dividends are declared by the Board of Directors and can be changed at any time. Companies that pay dividends may decide to stop paying them to shareholders for many different reasons.

In 2008, the S&P 500 had a dividend yield of 3.23% and this yield decreased to 1.87% the following year. There are no guarantees and stock trading is a taxable event.

High dividend yields can also be found in struggling stocks or struggling sectors. It is an illusion to assume that an expensive car means the owner is burdened; there may be a huge debt attached to it.

Recently, a federal judge ruled that the lawsuits against the 3M company can continue despite the bankruptcy of the 3M subsidiary. Interestingly, the company paid a dividend even though its share price is down about 30% this year and 50% from its 2018 all-time high.

General Motors had a 10% dividend yield as the stock plunged from over $60 in 2003 to under $20 in 2006. We have similar examples with Kodak, Radio Shack and Washington Mutual – once the most large savings and loan institution in the United States.

Buying a dividend-paying stock at the wrong time has terrible tax consequences. Check if a stock is close to the ex-dividend date, then check the record date and wait for the stock to pay the dividend and the price to drop. Missing this detail will result in an immediate tax impact as well as a drop in the stock price.

Dividend distributions come in two forms: ordinary and qualified. Taxpayers in the marginal 22% bracket pay a preferential tax rate of 15% for qualified dividends held for more than one year. This is taxed the same way as long-term realized capital gains, except it’s out of your control. 2021 has been a big year for surprises with dividends and capital gains.

Ordinary dividends are taxed as ordinary income, in this example the marginal rate of 22%. Even when reinvested, dividends are still taxed when issued. Consider using distributions to rebalance a taxable portfolio instead of reinvesting them.

Asset tracking can minimize taxes and is done by placing tax-inefficient investments, like dividend-paying stocks and inflation-linked treasury bills, in tax-deferred accounts like IRAs.

After:Break time exhausted: what should I do to align my personal goals and my finances?

After:I sold my house; I am close to retirement. Now, how should I invest this money?

Value stocks generally pay higher dividends and have a lower price-to-earnings ratio. Growth stocks often have higher market appreciation and often do not pay dividends. Having a combination of the two keeps the portfolio diversified and able to withstand all economic conditions.

Investing in cheap index funds as part of a total return strategy creates a mix of large and small stocks as well as value and growth stocks. It also avoids the risk of holding overweight stocks. I’ll say it again: the biggest risk to any portfolio is a large stake in a single stock position.

Fixed income securities are an important part of a diversified portfolio. Consider higher quality/shorter bonds and lately CD rates are much more attractive. Don’t discount small cap stocks since large cap stocks used to be small.

Don’t limit yourself to just one source of income; dividends are good, but so are capital gains and market appreciation. It’s not what you earn; that’s what you can keep. Dividends taxed as ordinary income are not tax efficient.

Mary Baldwin

A total return strategy offers more diversification and therefore less risk. Owning only dividend-paying stocks or funds can cause your portfolio to miss out on other important asset classes, like growth companies that invest in research and development.

Diversify, pursue a total return strategy, and manage and locate investments across different portfolios for tax efficiency. The ultimate goal is to create a retirement plan for sustainable income that will result in a peaceful and fun-filled future retirement.

Mary Baldwin, CFP®, is a paid financial planner at Buckingham Strategic Wealth in Indian Harbor Beach. Contact her at 321-428-4555 or [email protected]

For informational and educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. The views expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Wealth®. R-22-4250

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