Question: May I ask what your opinion is re “dividend growth investing”? The angle that attracts me is that if one could get by on the dividends alone (in addition to Social Security, pension, etc.), you would not be forced to sell assets to live on during a down market. As such that would constitute one’s hedge. Also, the dividend growth aspect theoretically trumps inflation.
Probably need a larger portfolio to start if you restrict your stock choices to reasonable yields. Homework, monitoring, skill and discipline are also required, so not especially low maintenance or worry free. In my case I’m most interested in the “distribution” phase of this approach as I’ve just retired. However, perhaps an early start for younger folks (our children) as an “income accumulation” strategy?
Answer: Virtually any equity strategy that is adequately diversified meets with my broad approval. So long as stocks are chosen from different industries, no more than 2% is put into any single company’s security, and non-U.S. companies represent a good portion of the total, I think a portfolio is acceptable, even when it differs considerably from one I might design.
That said, I wouldn’t be too keen to recommend this approach to either a retiree or a youngster, for a couple of reasons:
- Getting the diversification right is going to take a lot of work. Since some industries (e.g., utilities) naturally pay higher dividends, the selection process has to take special care to avoid ending up overly concentrated. And you’re likely to completely exclude many important and dynamic areas of the economy that are currently growing and likely to be paying low or no dividends. Certainly, though, one can reduce the danger by choosing, for example, the highest yielding security in each of 50 different industries, rather than just the 50 highest yielding securities overall. The nice thing is that you’ll probably have no trouble with global diversification since non-U.S. stocks typically pay higher dividends.
- In a taxable portfolio, high dividends mean unnecessary taxation for someone still in the accumulation phase of his life and higher taxation for a retiree. When you sell shares to finance retirement, a portion of the proceeds is nontaxable as the cost basis of the property. This means you need to sell less each year than you’d need in dividends to finance a certain level of cash flow in retirement because your taxes are lower.
Cash dividends come out of assets as much as sales proceeds do. On the day a company goes “ex-dividend” the stock price drops by approximately the dividend being paid. Dividends aren’t something extra on top of total return: they are part of it. That said, dividend-paying stocks are generally less volatile than average, and they have elements of the alternative indexing that I’ve discussed in other posts.
With my retired clients, we simply set a cash-withdrawal rate and I take care of the details of selling holdings to finance the monthly transfers to their bank checking accounts. For a do-it-yourselfer, if your assets are in a few mutual funds, it really isn’t that hard to replenish your two-year cash reserve (see earlier blog posts) on a quarterly or so basis and just delay replenishing your reserve during bear markets (rather than selling a lot of securities at the bottom). No need for a dividend strategy to avoid that.
Still, I can think of some people who would be more likely to increase the equity portion of their portfolio if they had the comfort of high dividends, and the equity-debt ratio is probably the biggest factor in determining the long-term growth and withdrawal sustainability of a portfolio. So if a high dividend yield is the only way to motivate that, go for it. But consider a mutual fund such as WisdomTree Global Equity Income ETF (Ticker: DEW), which has already done the hard work of diversifying adequately and is currently yielding around 4%, in the ballpark of the so-called “safe withdrawal rate.” Retirement is supposed to be pleasure not work.