Dividend Stocks Or Annuities: Which Is Better?

Up to date on August twenty third, 2021 by Bob Ciura

At Positive Dividend, we’re large proponents of investing in high-quality dividend progress shares. Among the many hundreds of dividend shares on the market, buyers can concentrate on the “cream of the crop”: the Dividend Aristocrats, and the Dividend Kings.

The Dividend Aristocrats are a bunch of shares within the S&P 500 Index with 25+ consecutive years of dividend will increase. You possibly can see all 65 Dividend Aristocrats right here.

You possibly can obtain an Excel spreadsheet of all 65 Dividend Aristocrats (with metrics that matter resembling dividend yields and price-to-earnings ratios) by clicking the hyperlink beneath:

There’s an much more unique membership than the Dividend Aristocrats — the Dividend Kings, a listing of simply 32 shares with 50+ consecutive years of dividend will increase. You possibly can see all 32 Dividend Kings right here.

The explanation why we’re so adamant about dividend progress shares is straightforward.

Analysis has proven the Dividend Aristocrats have generated increased risk-adjusted returns than the broader S&P 500 Index, over the long run.

In response to Normal & Poor’s, the Dividend Aristocrats produced annualized returns of 15.2%, in contrast with annual returns of 15.4% for the broader S&P 500 Index.

Supply: S&P Dividend Aristocrats Reality Sheet

However when it comes to risk-adjusted returns, which includes volatility (as measured by customary deviation), the Dividend Aristocrats produced increased annualized risk-adjusted returns over the previous decade.

You possibly can see this distinction within the picture beneath:

Supply: S&P Dividend Aristocrats Reality Sheet

Incomes a spot on the Dividend Aristocrats record is a good signal that an organization has sturdy aggressive benefits and a robust enterprise mannequin.

There are various monetary merchandise that buyers can construct a portfolio round. At Positive Dividend, we now have a specific fondness for dividend shares. However annuities are one other fashionable monetary car, utilized by thousands and thousands of People.

This text will compare-and-contrast dividend shares versus annuities.

Desk of Contents

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Why Make investments In Dividend Shares?

Given the returns generated by dividend shares talked about within the opening paragraph, a greater query may be: why not spend money on dividend shares?

The S&P 500 Index delivered annualized complete returns of 10%-11% from 1926 via 2018.

Even higher, shares that pay dividends (and lift their dividends frequently) have confirmed to outperform shares that don’t pay dividends. Dividends present a buffer in opposition to falling markets, and assist increase returns even additional throughout bull markets.

In 2008, the worst 12 months of the Nice Recession, the Dividend Aristocrats Index declined 22%, whereas the S&P 500 declined 38%.

The record of Dividend Aristocrats is balanced throughout market sectors.

Supply: Reality Sheet

The very best allocation of the Dividend Aristocrats is within the shopper staples, industrials, and supplies sectors. This could come as no shock, as these industries take pleasure in regular product demand from 12 months to 12 months, even throughout recessions.

Not all shares select to pay dividends to shareholders. Then again, many shares do pay dividends, and these are the forms of shares we concentrate on at Positive Dividend. Particularly, we steadily advocate buyers start their search with the Dividend Aristocrats.

The advantages of dividends could be neglected, notably throughout bull markets, resembling the present market rally that has gone nearly uninterrupted for the reason that finish of the Nice Recession. Traders tend to dismiss dividend shares as boring, particularly when markets preserve setting new highs.

However market downturns do occur, and by a number of financial measures, the U.S. inventory market seems to be overvalued.

For instance, utilizing the widely-followed inventory valuation metric referred to as the Cyclically Adjusted Value-to-Earnings ratio (additionally referred to as the Shiller P/E ratio), shares are valued at a price-to-earnings ratio of practically 39.

Supply: Multipl.com

The CAPE ratio relies on common inflation-adjusted earnings of the S&P 500 Index from the earlier 10 years. Based mostly on this metric, U.S. shares are presently buying and selling at their highest degree for the reason that tech bubble—which was quickly {followed} by a steep market downturn.

Going again additional, a Shiller P/E of ~39 is increased than each Black Monday and Black Tuesday. The median Shiller P/E ratio, going again over 100+ years, is simply 15.85.

Many high-quality dividend progress shares will not be as aggressively overvalued proper now as different sectors, resembling know-how shares. This can assist reduce the injury, throughout the subsequent market downturn.

Extra broadly, regular and rising dividends are an indication of a disciplined administration staff. Corporations that don’t pay dividends are underneath no obligation to return money to shareholders. That leaves quite a lot of money circulation left over every year, which can be utilized to profit shareholders, or not.

As a substitute of paying dividends to shareholders, administration pays themselves large bonuses, or conduct empire-building campaigns, marked by wasteful spending or silly acquisitions. Put merely, dividends preserve a administration staff sincere.

When markets are in rally mode, a lot of the consideration goes to the high-fliers, resembling tech shares. Dividends are sometimes seen as too boring—however nothing could possibly be farther from the reality.

Annuities: Execs and Cons

To make certain, dividend shares will not be the one option to construct wealth over the long-term. There are various totally different routes one can take, on the lengthy street to monetary freedom. Annuities also can serve a precious goal.

An annuity is a monetary contract with an insurance coverage firm. The purchaser of the annuity makes both a lump-sum, or periodic funds. In return, the insurer will make funds to the purchaser, sooner or later sooner or later, relying on the kind of annuity bought.

There are a variety of excellent causes to buy an annuity, chief amongst them the flexibility to handle revenue throughout retirement. Annuities present regular, periodic funds for a sure time period, such because the period of the purchaser’s life, or the lifetime of one other individual.

Annuities even have demise advantages. If the purchaser dies earlier than funds start, a chosen beneficiary can obtain the funds.

Lastly, annuities supply tax-deferred progress. Earnings and funding good points from annuities will not be taxed till withdrawals are made.

There are various totally different sorts of annuities, the three hottest being fastened, variable, and listed. A hard and fast annuity is the best type. The insurer gives a minimal rate of interest with fastened periodic funds.

Variable annuities can present increased returns than fastened annuities, but additionally have increased threat, because the insurer will direct annuity funds towards investments, resembling mutual funds. Payouts will differ, relying on the speed of return of the chosen investments.

The final kind of annuity is the listed annuity, which is a mix between an insurance coverage and funding product. An listed annuity tracks the efficiency of a benchmark inventory market index, such because the S&P 500 Index.

The enchantment of annuities is that they’re comparatively low-risk, notably in the case of fastened annuities. Mounted annuities have assured funds. Nonetheless, annuities will not be risk-free.

For instance, purchasers should contemplate the monetary power of the issuer. It’s important to evaluate whether or not the insurance coverage firm will nonetheless be round as soon as payouts are scheduled to start.

As well as, whereas fastened annuities are low-risk merchandise, variable annuities contain market threat, as buyers can be uncovered to the inventory market.

Annuities additionally carry charges, which is a big drawback, in contrast with investing in dividend shares. Whereas the one price of inventory market possession is brokerage buying and selling charges, which are sometimes very low, annuities typically have a large number of charges. For instance, annuities can cost administrative charges, mortality charges, and within the case of variable annuities, the mutual funds’ annual bills.

Charges can actually add up over time. For instance, say an investor purchases a basket of dividend progress shares that earns 10% per 12 months. A special investor purchases a mutual fund with a 1.25% annual expense ratio, and the mutual fund additionally earns 10% per 12 months. Assume a $10,000 funding in every case.

Within the first instance, in 30 years the dividend inventory investor may have a portfolio value $175,000. However the second investor will solely have $108,000—a distinction of roughly $67,000, or 38% lower than the primary investor. This reveals the dramatic influence of a seemingly-innocuous 1.25% annual expense ratio.

Furthermore, one of many greatest advantages of annuity possession—tax-deferred progress—may also be achieved with dividend progress shares. Traders can open a tax-advantaged account, resembling a office 401(ok) or an Particular person Retirement Account. And, in the case of the Roth IRA, all good points are tax-free.

Plus, returns from dividend progress shares are arduous to beat, notably after annuity bills are taken into consideration.

Actual-World Examples of the Energy of Dividend Progress Investing

To show the ability of dividend progress investing over lengthy intervals of time, buyers can contemplate healthcare big Johnson & Johnson (JNJ), shopper merchandise producer Procter & Gamble (PG), and beverage behemoth Coca-Cola (KO).

All three shares are Dividend Aristocrats, and are additionally Dividend Kings.

Contemplate the returns these shares have generated over the previous 30 years, had buyers merely purchased and held, whereas reinvesting dividends alongside the way in which. Up to now 30 years via August twenty third, annualized complete returns for J&J, PG, and KO totaled 12.1%, 11.9%, and 9.2%, respectively.

As you may see, all three shares supplied not less than 9% returns every year, over the previous 30 years. Importantly, the speed of return over these three a long time consists of reinvested dividends.

These sorts of returns could be extremely highly effective, over lengthy intervals of time. At a compound annual progress price of 9%, an funding doubles each 8 years.

J&J, P&G, and Coca-Cola share a couple of key qualities. Not solely do all of them pay dividends, and have elevated their dividends for 50+ consecutive years, however additionally they have sturdy manufacturers and sturdy aggressive benefits.

J&J has been in operation for 130 years. It’s a diversified healthcare firm, with an enormous presence throughout prescription drugs, medical units, and shopper well being merchandise.

On 7/21/2021, Johnson & Johnson launched second quarter earnings results for the interval ending 6/30/2021. Income elevated 27.1% to $23.3 billion, which was $770 million above what analysts had anticipated. Adjusted earnings–per–share of $2.48 was an $0.81, or 49%, enchancment from the prior 12 months and $0.19 higher than expected. Pharmaceutical gross sales stay sturdy, with income rising 17.2% 12 months–over–12 months.

It is without doubt one of the world’s largest healthcare firms, with annual income above $90 billion, and greater than 250 subsidiary firms. J&J inventory has a present dividend yield of two.4%.

In the meantime, P&G is a worldwide shopper merchandise big. It sells its merchandise in over 180 nations world wide. Notable manufacturers embody Pampers, Luvs, Tide, Achieve, Bounty, Charmin, Puffs, Gillette, Head & Shoulders, Outdated Spice, Daybreak, Febreze, Swiffer, Crest, Oral–B, Scope, Olay and plenty of extra. The corporate generates over $75 billion in annual gross sales.

P&G’s greatest aggressive benefit is its model power. Prime-quality merchandise and model recognition permit for regular progress every year. P&G has a present dividend yield of two.4%.

P&G has elevated its dividend for 65 consecutive years.

Coca-Cola is the world’s largest non-alcoholic beverage firm. It owns or licenses greater than 500 non-alcoholic drinks, together with each glowing and nonetheless drinks. It sells its merchandise in additional than 200 nations world wide.

The core glowing beverage portfolio consists of the flagship Coca-Cola model, in addition to different soda manufacturers like Weight loss plan Coke, Sprite, and extra. Coca-Cola additionally has a big portfolio of nonetheless drinks, together with Dasani, Minute Maid, Vitamin Water, and Trustworthy Tea.

Coca-Cola inventory has a present dividend yield of three%, and has elevated its dividend for 59 consecutive years.

Last Ideas

The great thing about high-quality Dividend Aristocrats and Dividend Kings, is that they’ve the flexibility to boost their dividends every year, whatever the situation of the general economic system. Together with sturdy enterprise fashions and industry-leading manufacturers, their dividends assist gasoline spectacular returns.

The perfect dividend progress shares, resembling J&J, P&G, and Coca-Cola, have supplied 9%+ annualized returns over the previous 30 years. Over lengthy intervals of time, these returns can present a safe monetary future.

Annuities also can serve a goal for buyers planning for retirement. Mounted annuities present assured payouts, whereas variable annuities present future revenue streams, with some publicity to inventory market good points.

Nonetheless, annual charges can erode returns generated by annuities, and make them comparatively unattractive compared with dividend progress shares.

Brokerage commissions have come down considerably up to now few years. Many brokerages now supply no commissions on inventory trades. Consequently, we consider shopping for and holding high quality dividend progress shares such because the Dividend Aristocrats and Dividend Kings is way extra preferential to paying 1.25% (or extra in some instances) every year, to spend money on annuities.

Shopping for particular person shares requires extra analysis, however the potential rewards are effectively value it.