Buy "Dividend Aristocrat" Stocks, Not Annuities
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In a recent interview in Money magazine conducted by George Mannes, financial advisor William Bernstein counsels that a near-retirement portfolio should be in "safe assets" such as "Treasury Inflation-Protected Securities, annuities, or even short-term bonds." The focus of the piece, "The Worst Retirement Investing Mistake," is on asset allocation, particularly shifting funds from stocks to "safe assets" such as annuities. Whatever the benefits of an annuity for a retirement portfolio, a "Dividend Aristocrat" stock can perform far better and with many other appealing features.
An annuity, as defined by the The Motley Fool, is, "Typically, an annuity agrees to provide payments to the purchaser of the contract (annuitant) beginning at some point in the future. Two kinds of annuities are most common: variable annuities and fixed annuities."
An annuity is not protected by a federal or state governmental entity. It is, in essence, only as secure as the insurance company that issues it. About this risk with annuities, one articles states quite bluntly, "If your insurance company goes out of business, then guarantees aren’t worth anything to you." There have been more than 60 insurance company insolvencies since the collapse of Executive Life Insurance Company in 1991. The state Guaranty Association funds, which are not government entities, offers the protection for annuity holders.
In addition to this risk, an annuity deprives the purchaser of a significant amount of flexibility in penalizing the owner with potential "surrender charges." An annuity carries with it substantial management fees as well. These expenses can be very high.
If an investor feels strongly enough to buy an annuity from an insurance company, than purchasing the stock of the firm makes more sense for retirement savings. What is even more advisable is to acquire "Dividend Aristocrat" stocks for a variety of factors. A Dividend Aristocrat is a stock that has raised its dividend for at least 25 consecutive years. That is a remarkable show of strength for a company. It is also a very compelling demonstration that the management is dedicated to returning capital to investors. It makes more sense to buy an insurance company that is a Dividend Aristocrat such as Aflac (NYSE: AFL) rather than an annuity.
Aflac has a superb dividend framework. Its dividend yield of 3% is much higher than the average of about 2% for a member of the Standard & Poor's 500 Index. With a low dividend payout ratio of only 26%, there is ample room for dividend growth or stock repurchase programs in the future. The dividend at Aflac is much higher than those from other insurance companies such as Unum Group, CNO Financial and AllState Corporation. As a Dividend Aristocrat, Aflac has a tradition of raising the income level paid to shareholders that does happens with few, if any, annuities.
An annuity is basically based on how well an insurance company invests. Much of that investing is in stocks and bonds. For the insurance company to prosper and honor its annuities, obviously it has to buy the equities and bonds of the best-performing companies.
Those are the Dividend Aristocrat stocks. Studies have shown that "over the past 10 years, companies with the highest dividend growth within the broad S&P 1500 index outperformed those with the highest dividend yield but the lowest dividend growth by more than 120 percentage points, a gain of 159% for the former compared to a gain of 36% for the latter."
Dividend income also provides much of the total return for a stock. According to investing legend Jack Bogle, who founded the Vanguard group of mutual funds and created the first index mutual fund, dividend income has provided more than 40% of the historic total return of a stock.
Dividend Aristocrats such as ExxonMobile (NYSE: XOM), Pepsi-Co (NYSE: PEP), Walgreen (NYSE: WAG) and Illinois Tool Works (NYSE: ITW) are blue chip firms with superior income components. Not only does each offer a present dividend income that is above the S&P500 average, but future growth is very likely based on the past. Company management, like that of Aflac, has demonstrated a commitment to provide increasing dividend growth in eah of these companies as well.
Most that can be achieved with an annuity for the purposes of asset allocation can be achieved with a Dividend Aristocrat stock. These stocks offer liquidity that no other investment offers, including an annuity. Stocks do not carry the burdensome expenses of surrender charges and management fees, as do annuities. Dividend Aristocrats also offer proven income that increases through raising the dividend. Only a sound, profitable company can achieve that level of performance in returning wealth to investors.
While more than 60 insurance companies have become insolvent, Dividend Aristocrats such as Aflac, Exxon-Mobile, PepsiCo, Walgreen and Illinois Tool Works have increased the dividends paid to shareholders for at least 25 straight years. This shows how solid a company must be with a culture focused on respecting the rights of all shareholders in sharing earnings like that to achieve Dividend Aristocrat status as that time span has included The Great Recession, municipal bankruptcies across the United States, The DotCom metldown, two wars in Iraq, 9/11, Black Monday, rising interest rates at various periods, increasing oil prices, and recessions in the early 2000s and early 1990s.
Rather than losing money for investors, a Dividend Aristocrat pays more to them in the form of increasing dividend income. Shareholders can look forward to rising income in the future, as it has been provided in the past by a company culture and management team dedicated to that commitment. That kind of proven performance over the decades is the most secure of "safe assets" for an investor at any stage of life, particularly into retirement.
Fool blogger Jonathan Yates does not own any of the stocks mentioned in this article. The Motley Fool owns shares of PepsiCo and ExxonMobil. Motley Fool newsletter services recommend Aflac, Illinois Tool Works, and PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.