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| Use an active investment management team that chooses investment opportunities based upon fundamental research |
PART 6 of 7 Series:
THE ROAD OF RETIREMENT
The Process of Managing Retirement Income
Over the past eighty-three years, dividends have accounted for approximately 40% of the total return for the S&P 500 Index. The importance of dividends has been an often overlooked part of investing, but will continue to come to the forefront as baby-boomers prepare for retirement and look for high and growing income generating investments.
There are generally two schools of thought regarding how best to fund expenses in retirement. There are many who believe a total return approach is optimal, whereby an asset allocation and total return is targeted for the portfolio and a portion of the retirement assets is sold periodically to cover expenses. While this approach attempts to provide the growth that retirees need to outpace the effects of inflation, they may also be forced to sell assets at an inopportune time.
A cow for her milk. A hen for her eggs,
And a stock, by heck, for her dividends.
An orchard for fruit. Bees for their honey,
And stocks, besides, for their dividends.
John Burr Williams,
"Evaluation of the Rule of Present Worth," 1937
The second school of thought follows a high income approach, whereby the portfolio is comprised of high yielding income investments in an attempt to generate sufficient current income to cover expenses. This approach can leave a retiree too heavily exposed to fixed income expenses and the ravages of inflation.
We will explore a third approach, which is a hybrid of the total return and high-income approaches. We will explore how an investment in stocks of companies that provide both high and growing dividend income can benefit a retirement portfolio undergoing the duress of withdrawals. This type of investment strategy can have the potential to provide a growing dividend income stream as well as capital appreciation needed by retirees.
Understanding Yield
When reviewing income generating alternatives, retirees often focus on current yield (the current income divided by the current price). This works well for fixed income investments, which are, essentially, contracts that pay a certain level of income to the bond holder each year and then return the principal amount at maturity. However, for equity investments, where both the income and stock price may appreciate, looking solely at current yield can disguise the growth in the actual dollar amount of the income generated.
Not only can growing dividends help contribute to the retiree's distributions, but the portfolio value may also have the ability to outpace inflation through price appreciation.
Dividend Income in Retirement
For most retirees, developing a growing dividend income stream should be an attractive alternative to the total return or high income approaches described earlier. Having the retirement portfolio generate sufficient income to cover expenses while the portfolio is poised with an opportunity for continued growth should be a goal for every retiree.
Best Practices
Before implementing a dividend grower strategy, there are two improvements that should enhance the portfolio's diversification and selection of attractive dividend opportunities. First, looking for companies around the globe that offer both a high and growing dividend, versus limiting the investment universe to just domestic stocks, may improve results.
Another benefit from using a global approach is the opportunity to improve the portfolio diversification by in by industry sector. In the United States where attractive dividends are typically concentrated in real estate and utilities. Outside the United States, dividend opportunities exist in a multitude of sectors.
The second improvement when implementing this dividend growers strategy would be to use an active investment management team that chooses investment opportunities based upon fundamental research. The decline of dividends for U.S. companies in the S&P 500 Index during 2008-09 has made the headlines recently, and even the Dividend Growers were not immune. It is important to use an active manager who can analyze both a company's willingness and ability to pay a high and growing dividend as a way to try and navigate around some of the dividend declines seen in the broader market.
As the baby boomer generation progresses on the road of retirement, a dividend grower strategy may be prudent addition to their equity portfolios, as part of a core investment strategy. Not only can growing dividends help contribute to the retiree's distributions, but the portfolio value may also have the ability to outpace inflation through price appreciation.
Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.
The performance of any index is not indicative of the performance of any particular investment. Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. Investors may not make direct investments into any index.
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