Cash flow is an important component of a retirement portfolio, and either dividend stocks or interest income investments can provide investors with a steady flow of payments to help cover living expenses. But there are several differences between dividend stocks and interest income investments. Whether one or the other is right for a retirement portfolio really comes down to how much risk the investor is willing to take to achieve the income he needs.
Ownership vs. Creditor
When an investor owns stock in a dividend-paying company, each share represents a partial ownership stake in the company. The dividend he receives from the company is his rightful share of the company profits that are distributed on a regular basis to its investors. Interest income investments, such as bonds and bank CDs, are essentially loans an investor makes to a corporation, a government entity or a bank. In return for the use of an investor's money, the bank, government body or corporation promises to pay a fixed rate of interest on the loan and return the initial investment at a specified date.
Rate of Return
Dividend stocks generally pay a higher rate of return than bonds and bank CDs, but that is because investors assume more risk when they venture into the stock market. The value of dividend stocks could go down. Bonds and bank CDs, on the other hand, are likely to hold their value. But while interest income investments such as bonds -- especially U.S. government bonds -- and bank CDs are considered to be safer investments, they also pay the lowest rates to investors.
Dividend stocks provide a retirement portfolio two ways to realize a return on investment. Owners of dividend stocks stand a better chance of having their income keep up with inflation. Successful companies tend to increase their dividend payments over time, and as share prices rise the value of the stock is greater. Interest income investments are more vulnerable to the negative effects of inflation. Bond interest and CD rates are usually set in stone for many years and the payments could lose their purchasing power. As prices of goods and services increase, the income from interest investments will not be able to buy as much.
Bond investors and bank CD owners are guaranteed to receive the interest checks they were promised when they bought the bond or CD. Dividends are not a sure thing. A company's board of directors can decide to either reduce or completely eliminate a dividend payment to shareholders. However, the company's bondholders will still get their checks in the mail. If a company files bankruptcy and liquidates its assets, bondholders get paid first. Dividend stock shareholders get what's left, if anything.
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