Dividend Investing For Retirement

[Dividend Growth Investor]

Hi everyone. Jacob has mentioned how he has been able to save 70-80% of his salary for several years, before being able to afford to retire. One aspect that I think can make or break your early retirement plans is your investment strategy. At the end of the day if you purchase the wrong investments, you could lose a lot of money and you might have to return to work, particuarly since you cannot live on $0.
What I am doing for myself ( besides saving a lage portion of income) is investing in dividend stocks for income. I find companies with strong fundamentals, that can grow earnings and that are attractively valued. I then check whether they have raised dividends consistently for over a decade and assess whether the current dividend is sustainable and whether the company can afford to grow it in the future.
I have a sample list of stocks that fit my criteria:

http://www.dividendgrowthinvestor.com/2 ... rowth.html
The goal of dividend investing in retirement is to create a passive income stream, where income rises at least at the pace of inflation.

http://www.dividendgrowthinvestor.com/2 ... me-in.html
I have written a few articles on dividend investing for retirement:
http://www.dividendgrowthinvestor.com/2 ... ement.html
http://www.dividendgrowthinvestor.com/2 ... idend.html
http://www.dividendgrowthinvestor.com/2 ... ng-in.html
I hope you enjoy these. I would also want to learn how ERE readers are investing their money in order to ensure longevity in retirement.

[erickonghl]

Total Return = Capital Gains + Dividends
Isn't it better to achieve a higher total return? If one goes for higher dividend paying stocks, it does not neccessarily mean a higher total return. Since stocks are quite liquid, one can always liquidate part of one's portfolio to realize the capital gains.

[jacob]

I personally prefer money in the bank to growth. This even means sacrificing dividend growth. If the return is 10% overall, say. I prefer a 10% dividend to 9% capital gains and 1% dividend (total return) or even 4% dividend and 6% gains (dividend growth).
Of course this means that 6% of my cash must be invested manually back.
This does not mean I'm religious on the issue. Just that I don't like growth (because I think it is really difficult to price regardless of whether it's earnings growth or dividend growth).
It may be because I have owned two stocks which were predicted on the latter two models.
Walgreens had a long long history of increasing their earnings and those enjoyed a great P/E. The first time they didn't meat their expected number, the P/E was hit hard!
General Electric had a long history with both earnings and dividend increases. Same story. P/E was cut handily.

[erickonghl]

Case 1 : What happens if you buy a stock with increasing earnings and dividends, and suddenly, their earnings did not meet expectations, or worst declined? And they reduced their dividends?
Case 2: What happens if you buy a stock with a recent past of declining earnings, and reducing dividends, to the point where dividends are cut? What happens if it restores dividends some day?

[Dividend Growth Investor]

Eric,
Just because a company pays dividends, doesn't mean that it cannot deliver total returns. The stocks I own pay up to 50% of earnings in dividends and reinvest the rest in the business. In addition to that I have found that dividend stocks have managed to outperform non-dividend paying stocks over the past 30 years.
http://www.dividendgrowthinvestor.com/2 ... -rock.html
For example companies I mentioned earlier in my first post have managed to not only grow business for extended periods of time, but also to pay higher dividends ( high dividend payment, not high dividend yields) as well. All the while these stocks have delivered solid total returns as well.
WalMart ,McDonalds , Coca Cola etc, are all household names and just a small sample of what I am talking about. There are only about 300 companies in the world which have raised dividends for over a decade, which makes it easy to start a manageable list of stocks to watch. Add in a few other criteria ( valuation, minimum yield,) and the list drops to less than 100.
Jacob,
I generally think that if a company can reinvest all of its earnings back in the business, and keep its return on equity that should be fine. But realistically, companies that reinvest all the money they have back in the business without paying a dividend do this because they cannot afford to pay a dividend. In other words in most cases, not paying a dividend is because the company has weak fundamentals. Exceptions such as Berkshire Hathaway are just outliers, not the norm.
Also, if a company cuts dividends I sell it, and reinvest the proceeds in other stocks. If earnings are low, but the company maintains distributions, then management is expecting earnings to improve soon. http://www.dividendgrowthinvestor.com/2 ... e-for.html
In a diversified portfolio of 40 stocks you could get one or two cuts per year. Below is my portfolio as of April:
http://www.dividendgrowthinvestor.com/2 ... -term.html
Oh yeah, Eric, I mentioned that I purchase stocks that increase earnings, and that increase dividends. Hence your Case 2 is not relevant. If a company does cut the dividend, and reinstates or starts raising it in a few years, I would check to see if its fundamentals can support more dividend increases. Dividend cuts are seen on case by casee basis.
Last but not least, dividends are better than relying exclusively on total returns, because dividend payment as a component of total return is more stable than price alone. In other words a diversified portfolio of stocks could generate 10% annual total return, but that could be several years of negative total returns followed by one year of spectacular returns. You need to eat during all those years. Dividends are more stable, they don't get cut that often in a diversified portfolio:
http://www.dividendgrowthinvestor.com/2 ... ncome.html
So dividends are more reliable and thus are better suited for would be retirees.( or retirees)

[chemkrafty]

While mathematically I agree with the idea of total return, it doesn't really take into account reality. The point was made in a previous post that you may have years of down stock price. By following a theory of growth harvesting you may be forced to sell during a period of non optimal pricing even if you maintain a safe pool of cash. This means that (1) you have reduced your ability to recover as you have fewer shares and (2) you have to maintain a larger pool of cash to account for it.
If you focus more on supplying your income using dividends, you will have a cash flow that doesn't involve market timing. It also is insulated from price fluctuations and you can ride out periods of low price stress free. Finally, it may not be essential to carry as much of a cash buffer to protect you from selling in low periods.
All that being said, being young I am definitely looking at dividend stocks that have the capability to provide price appreciation throughout the years, thus providing me the ability to grow my savings. But it also means I can ride out the lows recieving cash and buying low while I wait for things to go back up so companies can continue raising dividends!!!

[JohnnyH]

As much as I like the idea of dividend investing, I cannot reconcile myself to buy and hold.
Over 75% of an individual stock's movement follows that of the broader market. Meaning even the best of companies will mostly follow the market downward.
But on the other hand there are some great dividends out there... Maybe I'll sell OTM puts on them until they reach a price level I accept.

[jacob]

Or you could buy the stock, sell ITM calls on them at the same strike price (a covered call is identical to a naked put with a cash position) and score the dividend in the mean time.
[Just throwing the option out there for those who don't have access to naked put selling. (I'm looking at you Scottrade!)]

[Dividend Growth Investor]

chemkrafty
I am with you that selling stock to pay for your expenses is similar to cutting the tree branch you are sitting on
JohnnyH
Entry price does matter to a certain degree. But then if you know a stock is going to $1000 in 5 yearsand trades at $100 today( for example), would it really matter whether you buy it at todays price or wait for lower prices?
Dividend investing is somehow insulated from the whims of the market. As long as the companies I own are stable financially and generate earnings, then they will keep paying me my dividends. Therefore, it doesn't really matter how much the shares are selling for. Even if stocks are flat for another decade, the dividend is a great reason to hold on.
Jacob,
Selling calls and puts theoretically sounds like you are generating excess returns. In reality however, strategies of selling covered calls for example have not led to outperforming the S&P500 for example ( the benchmark buy-write strategies were used against):
http://www.dividendgrowthinvestor.com/2 ... lunch.html

[Q]

Can't wait till January when I have enough cash to finance dividend investing!

[Maus]

@Q

Sadly, just in time for the favorable dividend tax treatment to end with the sunsetting of the Bush tax cuts. Dividends will once again be taxed as ordinary income. Once you are actually ERE (at least at the level practiced by Jacob) that probably won't matter so much; but if you are still in the accumulation phase, as many of us are, it will take just a little bit bigger bite out of our capital.

[jacob]

@DGI - I know ... ATM covered calls mainly smooth out volatility by converting capital gains into income. The reason is that options are efficiently priced [with exactly that objective in mind].
That's why I only use them as a disciplined buy and a selling method only. (Mostly sell).
[On an interesting side note, volatility is still range bound---strategy: sell options when volatility is high, buy when it's low---although it seems that this opportunity is going away too; with massively bad side-effects, like, for example, the flash crash.]

[Dividend Growth Investor]

Jacob,
Using options is a good strategy if you know what you are doing ( you seem to know what you are doing). I agree that when you are thinking about selling a stock, you could sell calls against your position for example and earn a premium plus some upside. I have sold covered calls on stocks which have frozen their dividends for over 2 years and where I am trying at least to break even or to squeeze in a higher profit. But using options to smooth out your equity curve is a smart strategy..
My pet peeve with options is newsletters that tell you that you could sell a cash secured put and generate 3% for example in one month if it is not exercised and then annualize the returns.
Q and Maus,
One could avoid paying taxes on dividends if you set up a ROTH IRA. Bad news is you won't be able to access the money until you are in your late 50's. So if you want to have an ERE or just ER a ROTH IRA might not be an option. I would rather pay taxes now, than not being able to retire while I am still young ( relatively speaking of course )

[Q]

Maybe we'll get lucky and they'll renew 'em.
A ROTH IRA is what I was aiming for, as it will kick-in as a double back-up. I intend to use my current 401k as my way out - I posted a whole bunch about me in "My Journal".
I thought more people would be doing that since like 5 people said they would in the admin section...

[Steve Austin]

DGI, I'm not certain that the news about Roth IRAs and access to your money is so bad. I haven't needed to do this yet, but my understanding is that one's (contributions) may be withdrawn before one's late 50s as long as the withdrawn contribution was made 5 years prior to the withdrawal. It's one of the purposes of IRS Form 8606, and such withdrawals are considered Return of IRA Contributions, as if for any other kind of non-deductible contribution return. The good thing about the Roth account is that there is no confusion (accounting disaster) about a mix of deductible and non-deductible contributions.
So I think the gist here is to fund a Roth IRA early and often, grow the account via dividend investing, and keep the aged-5+ contributions as a deep reserve. It certainly beats any selling from one's taxable accounts. I reserve my standard deduction / personal exemption as offsets of RMDs on my regular IRA; I'm 30 years away from that concern, but I figure I'll have 30 years to practice finessing my regular IRA account for exactly this purpose. Until RMDs kick in, one can use the standard deduction / personal exemption to offset tactical partial conversions of regular to Roth IRA. (I've noticed this approach has become more popular since 2007.)
Anyone see any holes?

[erickonghl]

For simplicity of discussion, assume the 2 cases:
Case 1: Total Returns = Capital Gains + Dvd Yield

= 4% + 4% = 8%
Case 2: Total Returns = 2% + 0%
In the 2 cases, everyone would prefer Case 1. Case 1 means dividend paying stocks achieve a higher overall total return. And Case 2, are stocks that don't pay dividends, and at the same time only return 2% capital gains to make overall total returns of 2%
But would case 3 be preferable?
Case 3: Total returns = 8% + 2% = 10%
The 2% spread looks small, but is actually large when compounded over a 20-30 year period for early retirees.

[Steve Austin]

erickonghl, I (respectfully) take issue with the presentation of capital gains + dividend yield, for this reason: nothing around investment returns is a sure deal (there's always some kind of risk somewhere), but the dividend yield in my experience is a lot more predictable than is capital gains. In other words, it's much easier to plan -- even on the basis of rough and hazy figures -- for dividends annually than it is for capital gains annually (measured as a mean over some numbers of years).
Dividend yield is a hard, measurable phenomenon.
Capital gain is a soft, human behavioral phenomenon, and I never rely upon it (though I thoroughly enjoy exploiting it on the downside, getting excellent value when the behavior is fearful).
So if you were to, theoretically, change the "capital gains" in your total return equation to "earnings yield", you'd have something more measurable. (Earnings still not as tangible as dividends, but at least the second-order human behavioral aspects are not included in your planning.)

[pbkennedy]

You are not necessarily limited to 59.5 for retirement accounts. For the early but not extremely early retiree, it's 55 from your 401(k), 403(b) or 457 plan if you separate from service on or after age 55. There's also the annuity method for IRAs - you can always annuitize based on your actuarial lifespan. Here's a description: http://www.smartmoney.com/personal-fina ... free-7958/

[JohnnyH]

@DGI: how could this possibly be known? If it could, to hell with the dividends I'd put everything in way OTM calls!
DGI: "Entry price does matter to a certain degree. But then if you know a stock is going to $1000 in 5 years and trades at $100 today( for example), would it really matter whether you buy it at todays price or wait for lower prices?"

[Dividend Growth Investor]

Johny,
My idea was derived from Buffett's quote that he would rather own exceptional businesses at a fair price, rather than purchase a crappy business at a huge discount.
I am certain that companies like WMT, JNJ, PG, MCD will be around for the next several decades. So if you believe they will be successful, then whether you purchase WMT at $50 or $45 doesn't really make much difference in the grand scheme of things.