For the first time since 2009, Social Security recipients will get an increase in their checks in 2012, thanks to the Cost of Living Adjustment process. The average Social Security check to a retiree in January is expected to be $1,229, a 3.6% COLA increase compared to the $1,186 it would have been without that hike.
As nice as it is to get any sort of raise, whether you're already receiving Social Security or you anticipate getting it someday, you need to ask yourself two key questions:
1. Have your costs of living really risen only 3.6% since the end of 2008?
2. Do you want to live on just that $1,229-a-month average Social Security payment?
If the answer to either of those questions is no, then you need to fill the spending gap that Social Security won't cover in order to retire comfortably.
Where to Look for Income
Unfortunately, these days, there are pretty slim pickings for income-seeking investors. Bonds, a traditional source of investment income, are yielding abysmally low rates. Even the longest-dated and highest-yielding 30-year Treasury bonds carry an interest rate right around 3%. At that yield, with inflation running at 3.4% over the past 12 months, all you're really getting by buying those bonds is a promise that your money will lose its purchasing power less quickly than if you were just holding cash.
However, today's investors can find better options for income in a somewhat less conventional place: stocks.
Oh, sure, no stock dividend is guaranteed, as no company has the Federal Reserve's power to print dollars at will. That makes individual dividend-paying companies riskier than Treasury bonds. Still, with a solid strategy, these days you can build an arguably better overall income portfolio with stocks than with those bonds.
Indeed, you can even build a stock-based portfolio with both a higher current yield than those 30-year Treasuries and the ability to potentially raise its dividends faster than Social Security has been rising. To do that in a market that has no guarantees, though, you need to pick your investments carefully.
4 Simple Rules for Investing in Dividend Stocks
When shopping for dividend-paying stocks, follow these guidelines:
• Diversify appropriately: You don't need to buy every stock in the market, but you'll want to own companies across multiple industries. That way, if one company -- or even industry -- fails, your dividend income won't be completely destroyed. Remember, it was just a few years ago that the global financial system imploded, taking many seemingly "indestructible" banks along with it.
• Look for companies with stable financial foundations: Judicious use of debt can help companies grow faster than they would have by trying to rely only on their internally generated cash flow. Too much debt, though, can be deadly when an investment doesn't work out. Looking for companies with debt-to-equity ratios below 2 will keep you among the companies that have kept their debt levels manageable.
• Check up on the dividend-paying history: Companies with proven track records of raising their dividends are likely to continue doing so if at all possible. In part, this happens because those companies know the market treats their dividends as signaling devices that proclaim the true health of their operations. No executives want to disappoint the market, especially with their own bonuses on the line.
• Be sure there's still room to grow: As valuable as those dividends are to investors, they come from companies' after-tax earnings -- money that would otherwise be available to continue to build the businesses. Payout ratios below two-thirds of earnings leave the companies with enough funding to continue to build the business and keep that streak of dividend growth alive.
Building a portfolio based on stocks with those characteristics and dividend yields hugging the same 3% level that 30-year Treasuries pay these days tends to get you corporate stalwarts like these:
10-Year Dividend CAGR
Johnson & Johnson (JNJ)
General Dynamics (GD)
Source: S&P Capital IQ, as of Dec. 20.
There are still no ironclad guarantees, and you'll need to regularly keep an eye on the companies you buy to assure they're still worth owning. That said, in order to fill the spending gap that Social Security won't cover and give your income a chance of increasing at least as fast as your real expenses do, those types of companies are worth considering.
After all, unless your true costs of living have only increased 3.6% since the end of 2008, all you're really getting from Social Security is a promise that inflation's bite won't hurt as badly as it otherwise would. That's cold comfort when it results in a choice between food and heat.
At the time of publication, Motley Fool contributor Chuck Saletta owned shares of Johnson & Johnson and Intel. Click here to see his holdings and a short bio. The Motley Fool owns shares of Intel, Aflac, and Johnson & Johnson, and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Intel, AFLAC, Chevron, Johnson & Johnson, and PepsiCo, as well as creating diagonal call positions in PepsiCo and Johnson & Johnson and a bull call spread position in Intel.