But first, an important pitfall to avoid.
A piece of advice you can commonly hear or read is the best way to ensure retirement income is a heavy allocation of high dividend-yielding stocks and/or fixed income with high coupon rates.
First, this confuses income with cash flow. Dividends and coupon payments are indeed considered income—you report them as such on your tax returns. Nothing wrong with these two sources of cash flow. But if you rely on them solely, you could be selling yourself short.
Finance theory is clear: After taxes, you should be agnostic about the source of your cash flow. It doesn’t matter whether you get cash flow from dividends, a coupon or the sale of a security. What’s most important is you remain optimally invested based on a benchmark appropriate for you. And a portfolio full of high-dividend stocks may not do it. Why?
All major categories of stocks come in and out of favor—including high-dividend stocks. Value and growth trade leadership, as do small cap and big cap. All major sectors rotate—going through periods they lead and periods they lag. This is no different—sometimes high-dividend stocks do really well, and sometimes they do dreadfully.
There’s nothing inherently better about a firm that pays a dividend—it’s just a different way of generating shareholder value. For example, if a firm can generate more shareholder value by reinvesting profits, it may choose to do so rather than paying a dividend. ...