When a person prepares to retire, he may choose to live on an income derived from his investment portfolio. While some retirees will invariably choose to buy a number of stocks and sell them after they appreciate, others may wish to live off dividends from these stocks. In addition, some may wish to live off the interest derived from bonds. These approaches have various advantages and disadvantages.
Perhaps the biggest advantage of receiving income from dividends is that they do not expire. If a company remains solvent and successful, then the person receiving dividends from the stocks can expect to receive dividends for an indefinite period of time. In addition, if the company becomes more profitable, the dividends will likely increase and the stock will appreciate in value.
The downside to receiving dividends from stocks is risk. There is the obvious risk that the company will lose money and lower the size of its dividends -- or, worse still, will go out of business -- but also the risk that the company will choose to pay less money to its stockholders and instead reinvest the money. In addition, the stock price could collapse.
The advantage of interest is that, so long as the company issuing the bond to which the interest is attached remains solvent, you can expect to receive interest payments regularly on a predictable schedule -- which is not true of dividends. This allows for better financial planning. In addition, depending on the type of bond you select, the yield on the bond may be higher than the dividends offered by the stock's company.
One of the main problems with receiving interest payments from bonds is that you will be required to reinvest your money after a bond comes to maturity, meaning you will have to research new investments regularly. In addition, there is the chance that the bond issuer will default. Also, the potential upside for the value of the bond is not as large as for a stock, particularly a growth stock.
- "Personal Finance for Dummies"; Eric Tyson; 2009
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