Relying on dividend shares for a passive income in retirement may become an increasingly likely scenario for many people. Low-interest rates mean that income-producing assets such as cash and bonds may be unable to provide a sufficient income to cover living costs in older age.
Clearly, dividend shares are riskier than many other mainstream assets. However, through holding cash for emergencies and identifying high-quality businesses, it may be possible to rely on dividend shares for a passive income in retirement.
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The risks of holding dividend shares
Dividend shares experience price fluctuations like any other asset. However, capital returns may not be the main priority of retirees. They may be more focused on the level of income received from their portfolio. This could prove to be unreliable due to the risks faced by the world economy.
For example, many income shares have decided to reduce or cancel their dividends in response to the uncertain operating conditions they now face. A retiree who holds such companies will now experience a fall in their income in the short run. Although dividends may return among businesses who have delayed or cancelled, there are no guarantees that this will take place.
Therefore, relying on dividend shares for a passive income is a riskier strategy compared to holding lower-risk assets. There is always a chance that dividend cuts will negatively impact on your level of income.
Low relative returns
The problem facing retirees is that, in most cases, dividend shares offer a far superior income return than other mainstream assets. Low-interest rates mean that cash and investment-grade bonds may provide an insufficient level of income. Since policymakers may attempt to support the economy's recovery through a loose monetary policy, the prospect of higher interest rates seems limited.
Building a portfolio for dividend shares
Therefore, many retirees may find that they focus their capital on dividend shares in order to generate a sufficient level of income. Should this be the case, buying a diverse range of businesses could help to lower your risks. You will be less reliant on a small number of companies to provide a passive income in retirement.
Similarly, purchasing companies with defensive business models and sound finances could further strengthen your passive income. They may be better equipped to survive an economic downturn, and therefore less likely to reduce their dividend payments.
Investors may also wish to hold cash to provide support and peace of mind should dividend cuts be ahead. This would also provide financial resources to overcome challenging economic periods that limit dividend-paying shares over a period of time.
