A Dividend Income Strategy Must Account for Potential Yield Reduction

Equity dividend yields are an essential element in the portfolios of many investors.  Dividends enable investors to directly receive free cash flows that exceed a company’s value-creating reinvestment opportunities, enabling that cash to be used for better investments or useful consumption. 

Investors may benefit from dividends in a number of different ways; for instance, a retirement portfolio can use dividends to pay a monthly distribution to a retiree to cover living expenses, or a pre-retirement investor can employ dividend cash to reinvest in a dollar-cost averaging strategy to build wealth. 

However, because dividends come from a company’s free cash flow, dividends are not necessarily stable. Companies can (and often should) reduce or eliminate dividends in an environment of economic distress.  As this Forbes article notes, futures markets are currently predicting a “27% reduction” in S&P 500 dividends.  An investor needs to account for this reality and make portfolio allocation decisions accordingly. 

Read more on this subject here: https://www.forbes.com/sites/baldwin/2020/04/16/how-much-will-your-dividends-get-cut/