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Dividends Can Pad Retirement Cushion

When you reach 50, you start looking for some answers. Where is life's highway taking me? How much will it cost to get that tattoo removed? And how can I generate some income when I retire?

The answers:

- Poughkeepsie.

- A lot. Hurts, too.

- Dividend-paying stocks.

If you start buying dividend-paying stocks now and reinvest your income, you'll have a powerful stream of dividends when you retire. As a bonus, blue-chip dividend payers are somewhat out of favor now, so you can buy them cheap.

Companies pay dividends from their earnings as a cash reward to shareholders. For most of the stock market's history, dividends were the bulk of the overall return from stocks.

Dividends fell out of favor during the technology boom of the 1980s and 1990s. Companies argued that it was better to buy back shares of their own stock than pay out dividends. By repurchasing stock, they reduced the number of shares available, and in theory, made remaining shares more valuable.

This was certainly a good strategy for CEOs whose pay was based on a company's stock price. Unfortunately, companies that repurchased stock during the tech bubble made the same mistake as other investors at the time: They bought at horribly inflated prices. Despite the repurchases, companies and investors alike still lost vast sums of money during the bear market.

During the 2000-02 bear market, investors rediscovered the charms of dividend-paying stocks. After all, a dividend payment is a great way to cushion a downturn. If your stock falls 10 percent but you have a 3 percent annual dividend payout, your total return - price movement plus dividend income - would be minus 7 percent.

Why are they out of favor now? When a company cuts its dividend, Wall Street slashes its stock price. Most investors see a dividend cut - rightly - as a last-ditch attempt to cut expenses. And 2009 was the year of the dividend cut - 804 companies cut or eliminated their dividends, vs. 110 in 2007. Overall, companies in the Standard&Poor's 500-stock index paid $51.6 billion less in dividends last year than they did in 2008.

Many of the best-performing areas of the stock market last year were the most speculative: When emerging markets are up an average 74 percent, why spend time with a stodgy company that pays a 3 percent dividend?

Well, here are three reasons:

- Even though dividend yields are relatively low - an average 2.03 percent - they still play an enormous role in your long-term total return. A $10,000 investment in the S&P 500 15 years ago would be worth $31,900 now, including reinvested dividends. Without dividends? $24,300.

- Most of the dividend cuts are over. "If you haven't cut dividends by now, you're not going to," says Keith Goddard, president of the Tulsa-based Capital Advisors. "And many companies are a quarter or two from bringing them back."

- Companies often raise their dividends. No matter how long you've held a bond, your issuer isn't going to bump up its payout. But companies often do, and that can be a good hedge against inflation.

S&P has a list of 44 companies that have raised their dividends every year for the past 25 years. (www.standardandpoors.com). They include Aflac (ticker: AFL), Coca-Cola (KO) and ExxonMobil (XOM).

If you start investing in dividend payers now and reinvesting those dividends, you can get a nice stream of income when you retire. Goddard thinks that AT&T (T) is one place to start. Ma Bell's dividend yield - past 12-month payout divided by price - is 6.73 percent.

Normally, you should be wary of a company with a soaring dividend yield, because a cut may be in the offing. But AT&T is a leader in mobile computing, one of the hottest trends today.

The stocks in the chart are all members of the S&P 500 and all have dividend yields between 3 percent and 6 percent. If you want a more diversified portfolio, consider the SPDR S&P Dividend ETF (SDY), an exchange traded fund that invests only in the S&P Dividend Aristocrats, or the WisdomTree LargeCap Dividend ETF (DLN).

Of course, dividend investing isn't only for people who are in their 50s: Reinvesting dividends over 30 or 40 years can yield exceptional results. But if you're of the age where retirement income suddenly seems interesting, then dividend stocks should interest you.

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