Augmented Dividends Strategy

Dividend amounts normally grow faster than inflation. Even the S&P500 dividend amount grows about 1% per year faster than inflation. A portfolio focused on dividends can do much better.

Retirees who live off their dividends can expect their standard of living to rise. The problem is with the starting point. The exchange traded fund DVY yields only 3.0%.

A TIPS ladder can come to the rescue. You can draw down enough of the TIPS principal to augment your income in the early years. You can rely on dividend growth to make up the difference later.

For those of us who expect stock prices to fall significantly within the next five or ten years, owning a TIPS ladder will allow us to pick up more shares of high quality dividend payers than we can today. If necessary, we can wait twenty years or more at today’s 2%+ TIPS interest rates (above inflation).

I examined what is reasonable in Dividend Growth to the Rescue. With care, it is reasonable to withdraw 4.0% of the original portfolio balance (plus inflation) from a combination of 50% TIPS and 50% dividend stocks (3% initial dividend yield). To generate a continual income stream of 4.0% (plus inflation), the dividend amount needs to grow 2.5% per year faster than inflation.

Dividend Growth to the Rescue

I ran a sensitivity study. I called it Dividend Growth Baselines. Even if stock dividends grow only 1% faster than inflation, you can withdraw 3.5% to 3.6% of the portfolios original balance (plus inflation) indefinitely. What is even better? You can do this with just about any allocation of stocks and TIPS between 20% and 80%. In the extreme case, with a 20% stock allocation, (real) stock prices would have to drop in half by Year 20 in the absence of dividend growth. In reality, any significant price drop within twenty years would do the job.

Dividend Growth Baselines

Even the most conservative retiree can design a portfolio to withdraw 3.5% of his original balance (plus inflation) far into the distant future. He can withdraw 4.0% of his original balance (plus inflation) comfortably at minimal risk.

Asked What Do I Really Think About Dividends?, I wrote:

“Dividends raise today’s Safe Withdrawal Rate to 5.4% (plus inflation) of the portfolio’s initial balance.”

“Dividends extend the portfolio lifetime indefinitely, well beyond 40 or 50 years.”

What Do I Really Think About Dividends?

I still believe that 5.4% of the original balance (plus inflation) is accurate. I advise retirees to start out at a lower rate to increase their comfort.

Have fun.

John Walter Russell
January 2, 2007