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You could live off dividends. Although stocks on average yield only 1.7%, it is quite feasible to assemble a collection of blue chips that are paying out 3% of their purchase price. That means a $1 million pot could produce $2,500 of monthly income, with reasonable prospects for seeing that income keep up with inflation over the next several decades.

You could do this yourself, buying a lot of dividend-rich stocks on your own. Or you could have the work done for you by owning a fund. This guide will steer you to 36 excellent choices—8 open-end funds and 28 exchange-traded ones—that yield 3% or better.

These funds are cost-efficient. The open-end (that is, traditional mutual) funds on this list are no-loads running up expenses no higher than 0.25% of assets annually. The ETFs cost no more than 0.15% annually.

Example: the iShares Core High Dividend ETF, whose $5.6 billion is invested in AT&T T +0.9%, Exxon Mobil XOM -0.6% and 73 other stocks. Expenses are a very reasonable 0.08%, or $8 annually per $10,000 invested.

Pay attention to expense ratios. If you are not careful, you can send a lot of money down a drainhole. This principle will be illustrated below.

Here are the winning funds:

By historical standards, a 3% yield from stocks isn’t terrific; the average payout rate over the past century is considerably higher. But you take what you can get. For a retiree aiming to live off a portfolio without eating it away, blue chips are a lot more plausible than bonds these days. U.S. Treasuries due in 2040 yield only 1%, and they are guaranteed to fail at keeping up with the cost of living.

Stocks, unlike those Treasuries, are risky. They periodically crash. You can perhaps withstand that uncertainty. You could put some of your money in low-yielding bonds and plan on selling bonds, not stocks, if and when you need extra spending money during a bear market.

There’s more to reflect on than the risk. Here are five other things to think about before making a big commitment to high-dividend stocks as a source of retirement income.

1. You’re making a trade-off. Growth and yield are two different ways to get a total return. More of one means less of the other.

You can choose the mix. Young savers might prefer growth, owning companies like Netflix NFLX 0.0% and Amazon AMZN -0.7%, which pay out nothing but are fast-growing. Retirees might prefer AT&T and Exxon, which pay rich dividends but are on a plateau.

The average stock falls between these extremes. The Vanguard Total Stock Market index fund yields 1.7% and owns companies that collectively grow at a moderate pace, faster than Exxon but slower than Amazon.

It is delusional to think that you can have high yields without sacrificing growth. If stocks yielding 3% had as much growth as the average stock, then their total return would be 1.3% higher than the total return on the market. And if that were true, we could all become arbitrage billionaires by owning the high yielders while shorting the market. This is not going to happen.

Accept the reality. To get a high yield, you have to give something up.

2. Dividends aren’t the only way to draw income. If you need to spend 3% of your portfolio every year, you are not compelled to buy stocks like AT&T. There’s a second method to obtaining cash. You could invest in stocks with lower dividends and sell some shares periodically.

You could, for example, buy that Vanguard fund covering the whole market (its ticker is VTI), pocket the 1.7% in dividends, and then supplement the income with the sale every year of 1.3% of your fund shares.

Go with the high-dividend funds if you prefer. There is something appealing in that arrangement to people who were trained by the grandparents to never “dip into capital.”

The truth, though, is that the sustainability of your capital is not determined by its current yield, or by the number of shares you sell off. It is instead determined by your total return. Don’t assume that your capital will last any longer with a high-dividend fund than it would with VTI.

3. You can wind up with a lopsided portfolio. Aim for the very highest yields and you’ll probably have an overdose of oil companies, real estate investment trusts and European stocks. These might do very well for the next decade, but they might do horribly. Pay attention to diversification. In selecting from the high-yield list, don’t overdo the sector and global funds.

4. There will be cuts. Derivatives speculators in Chicago are betting that the dividend on the S&P 500 index will fall from $58 in 2019 to $56 in 2020 and $51 in 2021 before beginning a slow recovery. Allow for this. The yields you see in the table sare for a trailing 12-month interval. They somewhat overstate what you’re likely to collect in the near future.

Cuts are especially likely among the energy funds with double-digit yields.

5. Costs matter. The funds on our Best Buy list are cost-efficient. A lot of what brokers sell is not.

Paying more costs than you have to can do serious damage. An incremental percentage point of cost compounds, over 30 years, to a 26% slice out of a static account (one without contributions or withdrawals).

Some investors are incapable of conceptualizing this. To illustrate, I will cite one curious fund that is much sought after by yield seekers: Gabelli Equity Trust.

This closed-end uses borrowed money to buy more stocks, which means that it should have outsized returns in bull markets and very bad results in bear markets. How has it done? Not well. Despite the leverage, it hasn’t kept up with the bull market over the past decade.

Given that disappointment and the fund’s savage 1.3% expense ratio, you’d expect that shares would trade at a hefty discount to the portfolio value. Instead, they trade at a 3% premium.

I aim to help you save on taxes and money management costs. I graduated from Harvard in 1973, have been a journalist for 45 years, and was editor of Forbes magazine from 1999 to 2010. Tax law is a frequent subject in my articles. I have been an Enrolled Agent since 1979. Email me at williambaldwinfinance — at — gmail — dot — com.

Source: https://www.forbes.com