The Motley Fool

Why dividend stocks can offer a steady passive income in retirement

The recent performance of global equities may dissuade many income-seeking investors from buying them to generate a passive income. In the short run, stocks could experience losses which erode the value of your portfolio.

However, through buying a diverse range of strong businesses, you may be able to benefit from the high yields that are on offer across the stock market.

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Furthermore, with equities having recovery potential over the long run, you could generate significant capital returns in the coming years.

Short-term risks

The prospects for the world economy continue to be highly uncertain. Perhaps the last time that investors were as risk averse as today was during the global financial crisis. Should the impact of coronavirus on the world economy’s performance last for a period of many months, it could lead to weaker investor sentiment and lower levels of profitability for a wide range of industries. This could mean that investors experience substantial paper losses in the near term.

Recovery prospects

In many cases, though, those risks appear to have been priced in to valuations. Investors seem to be expecting the spread of coronavirus to take place over an extended time period that will depress economic activity for more than just a matter of weeks.

This provides long-term investors with the opportunity to buy undervalued stocks while they offer high yields. And, with the world economy having always recovered from its recessions to return to boom periods, the long-term outlook for dividend stocks continues to be positive.

Through buying businesses that have highly affordable shareholder payouts, you can reduce the risk of experiencing dividend cuts in the near term. Furthermore, owning a variety of companies that operate in different sectors may limit the impact of dividend cuts and falling share prices on your wider portfolio. This may lead to a stronger and more resilient income stream in the coming months.

Income opportunities

At the present time, income-seeking investors are extremely limited in their choice of assets. Cash and bonds are unlikely to provide them with a sufficient income to enjoy financial freedom due to low interest rates. Property may become more attractive over time, but the yields and valuations on offer do not appear to be as attractive as those within the stock market.

Therefore, buying dividend stocks seems to be the most effective means of generating an attractive income return on your capital. There are clear short-term risks, but they can be mitigated through diversification and by focusing on the strength of the companies you own.

In the long run, the current economic crisis facing investors could prove to be a buying opportunity. Past crises have delivered similar falls in stock prices, only to be followed by a recovery. The track record of the stock market suggests that a similar end result will take place in the coming years.

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