As investors approach retirement, they often seek out income-generating assets to supplement their pension or Social Security benefits. One popular choice is dividend-paying stocks, which can provide a relatively stable source of income. However, not all dividend stocks are created equal, and investors need to be aware of the potential pitfalls.

Don’t Chase Yield

Brennan Decima, owner of Decima Wealth Consulting in St. Petersburg, Florida, warns against chasing high dividend yields. “Higher yields can often mean higher risk,” he said. “Instead of focusing on yield, look for companies with solid balance sheets, consistent earnings, and sustainable growth.”

More Than Just Yield

Investing in dividend stocks alone doesn’t paint the entire picture. For example, NVIDIA, which offered a relatively low dividend yield, became the first company to reach a $4 billion market capitalization earlier this month. This highlights the importance of considering other factors, such as earnings growth, valuation change, and payout sustainability.

Understanding Dividend Sustainability

“A company’s dividend is not guaranteed and can be cut,” said David B. Rosenstrock, director of financial planning and investments at Wharton Wealth Planning in New York City. “Look for companies that have steadily increased their dividends over time, as this is a good measure of the health and sustainability of the dividend payment.”

Market Downturns and Rate Sensitivity

Dividend stocks are still exposed to market downturns and often cluster in rate-sensitive sectors, such as utilities, financials, and telecom. These sectors have lagged as interest rates rose, said Dean Lyulkin, co-CEO of Cardiff Financial in San Diego. “By contrast, companies with small or non-existent yields offer the greatest return opportunities looking ahead to 2025,” he said.

Risk Tolerance and Dividend Investing

“Higher yield means higher risk, and the key is to understand your overall risk tolerance for this part of your portfolio,” said Michelle Hobart, founder of Fairfield Coastal Financial in Fairfield, Connecticut. “Dividend stocks can play a role in generating income, but they’re not magic.”

Business Prospects and Dividend Cuts

Dividend stocks are still stocks, and business prospects can and do change significantly, said Asher Rogovy, chief investment officer of Magnifina in New York City. “Some companies must cut their dividend in response to economic weakness, and they won’t grow as quickly as others,” he said.

Choosing the Right Stock

The process of determining if a stock is a good investment doesn’t differ much if the company pays a dividend or doesn’t, said Don Nesbitt, senior portfolio manager at F/m Investments in Washington, D.C. “Investors often get attracted to a stock just because of the high yield, but this isn’t a guarantee that the dividend will be there forever,” he said.

Fundamental Analysis and Cash Flow Profile

“Our fundamental analysis examines the growth and consistency of cash flows, as well as the company’s cash flow profile to make sure it can cover its dividend with room to invest in future profitable projects,” said Rob Swanke, senior investment research analyst at Commonwealth Financial Network in Boston. “This puts in a quality check on our process that should help in times of market turbulence.”

Key Factors to Consider

• Earnings and cash flow growth
• Balance sheet strength, including liquidity
• Valuation, both relative to the market and history

Other traditional factors, such as earnings and cash flow growth, balance sheet strength, and valuation, are also important considerations when evaluating dividend-paying stocks, said Swanke. “A company can’t sacrifice the growth of the business just to support a dividend,” he said.

Conclusion

Dividend stocks can be a valuable addition to a retirement income portfolio, but investors need to be aware of the potential pitfalls and consider multiple factors beyond just yield.