Yes, You Can Retire On Dividends

Co-produced with Treading Softly.

The older I get, the more I realize just how expensive life can be.

When you’re younger, your first paycheck makes you feel like a newly minted member of the upper class of society. Yet the reality is that your fast-food paycheck is nothing when it stacks up against the realities of adulthood expenses.

The older we get, the more expensive life can become as we buy a house or pay rent, raise children, and pay for our bills. When people are in their 20s and 30s, their income will rise rapidly, but so too does the expenses tied to their life as they get established and have a family.

Many don’t start thinking of their retirement plans until they hit their 40s, and retirement is only 15 years away. Now they feel like they’re in the 4th quarter, and the other team has been getting touchdowns while they’ve been changing diapers.

The classic formula for retirement is to hold a portfolio of 50% equities, like the S&P 500 (SP500), and 50% bonds, like the Vanguard Total Bond Market ETF (BND). Once you’ve built that portfolio, you’d take 4% out annually to live off of, adjusting for inflation, and you’d pray your portfolio makes it the entire length of your retirement.

This works great so long as you rigidly follow it and time your retirement effectively. The built-in assumption is that the market would return 7% annually, and inflation would only amount to 3%. Thus, if you take out 4%, you’ll be able to repeat this process indefinitely.

As you know, inflation has not been a steady 3%, and recently it’s spiked strongly while the market posted negative returns. In those instances, you’ll be eroding the value of your overall portfolio to live, leaving less starting money to cover your next withdrawal the next year.

In recent times, the ability of a 50/50 portfolio to meet your needs has declined rapidly. Once yielding over 5%, a 50/50 equity and bond portfolio now is yielding less than 2%. (Source: irrelevantinvestor.com.)

So what can a person do, if they want a great retirement without having to stress and worry over their financial stability?

Live off of dividends. Yes, you heard that right. It’s entirely possible and plausible to do that!

Dividends provide a route to enjoy long-term income which covers your financial needs without having to resort to asset sales. There was a period of time when people wanted to leave assets to their children, which was one of the key ways that generational wealth was created, by passing it downward. Yet, as the 4% rule became popular, more and more people were forced into an orderly dismantling of their estate instead of leaving an inheritance to people they love or causes they support.

Dividends Are Becoming More Necessary For Long-Term Income

We’ve survived a long time period where we lived in a zero-interest-rate environment. This led to rock-bottom CD interest rates, low municipal bond rates, and low income from traditional safe haven investments.

We lived in a spending-benefitting environment. You could get money from a bank very cheaply at low-interest rates, which meant your bank accounts and other debt products offered a pittance of income. Yet, when the 4% rule was popularized, we lived in a saving-friendly environment. Interest rates were higher, and thus banks paid top dollar for your life savings to lend it out and reap major profits from it.

Right now, we find ourselves somewhere in the middle:

Are CD rates climbing? Yes. They moved from below half a percent to around 1.28% nationally. It is important to note that 1-year CD rates are higher than 5-year rates. This means banks are thinking rates will drop within the next 5 years and are unwilling to pay you more for holding your money longer than a short-term CD.

Likewise, Treasury yields show a similar dichotomy, although it is larger due to the time difference – 1 month vs. 30 years:

What does this mean? Well, just like previously, relying on yields from bonds, CDs, and Treasury Notes means you will likely see declining income and yields as we look further into the future. Banks and institutional investors expect cheaper dollars in the future, so they are unwilling to pony up big bucks for your money now.

To create a livable yield for the long term, you need to move deeper into the market and no longer remain on the sidelines hiding in these other options. Otherwise, your income generated on assets will be next to nil as we look into the future. A high yield on a 1-year CD only kicks the can down the road a year, that’s not a long-term sustainable choice.

As more and more retirees realize their savings are not meeting their needs, and the desire to leave an inheritance behind means they don’t want to wind down their assets to survive, they are pushed toward finding income elsewhere.

Living on Dividends Means More Income From Less Capital

When you compare a portfolio withdrawing 4% or a dividend income portfolio, you can readily make the equivalent income on fewer initial assets, or generate much more income from the equivalent asset base.

The High Dividend Opportunities Model Portfolio aims to generate a 9% yield from its array of holdings. That means a $1 million portfolio would pay out $90,000 or over double what a $1 million portfolio would provide using the 4% withdrawal rule.

Or, on the other hand, you could generate $40,000 from $445,000 – less than half of your millionaire friend.

This allows your retirement dream to be much more readily achievable.

The potential for more income from safer places abounds, you just need to know where to look for those opportunities.

There are skilled individuals that go catfishing with just their bare hands. They can walk into a river or stream and pull out a monster catfish from a hole. That doesn’t mean you can walk to any river and shove your hand in a hole and yank out success. It takes skill, knowledge, and patience to develop those skills.

Likewise, finding reliable income in the market means knowing where the holes are and reaching in to pull out excellent opportunities to hold for decades to come.

Investors, when thinking of dividends, will often flock to the old faithful like Coca-Cola (KO) or PepsiCo (PEP). Yet I have found, if you really want to generate high levels of income from the stock market, you need to move past the overpopularized names and go into where money is really being made in the economy.

I buy those companies involved in keeping the economy moving, keeping gas at your local gas station, or keeping your lights on. These opportunities provide higher levels of income and are less known.

Your Unique Goals Met by a Uniform Solution

Each of us is unique. No two people share identical backgrounds, life stories, or personal interests. You might meet your doppelganger, but even while you look similar, you won’t be copy/paste individuals.

The constant between all of our lives and choices is that money is required. Every one of us has bills to pay and things we must afford. If you want to travel, you’ll need money. If you want to kick back at home and watch the sunset, you’ll be paying expenses related to that home and property.

This is the beauty of income investing. While you and I are entirely unique and different from one another, the method is uniform. Members of my investment community and other income investors all seek the same reliable income from steady and strong sources. We use debt instruments, dividend-paying companies, and preferred securities to achieve our goals.

Dividends are the lifeblood of millions of retirees’ income cash flow. While you could withdraw 4% annually and slowly dismantle your assets, another strategy is to invest for dividends and enjoy higher income from reliable sources.

When is the best time to get started? Yesterday was the best time, and now is the second-best time. Get your portfolio into income-producing investments, and you’ll come to see why so many retirees stop stressing about market movements and instead unlock more time to explore their favorite hobbies.

We’re all on our own unique life journeys, but you don’t need to reinvent the wheel before you drive your car. Likewise, you don’t need to reinvent investing to unlock success in the market. Let dividends pay your way. I can’t wait to see your accomplishments!