The Dividend Advantage

Withdrawals during retirement are similar to dollar cost averaging operating in reverse.

Dollar cost averaging in a fluctuating sideways market lowers the average cost per share purchased. The greater the volatility, the better--during accumulation.

In retirement, you are better off with lower the volatility. Increased volatility reduces the average cost per share sold. You need to avoid selling shares when prices are low. This is what kills retirement portfolios. It reduces the Safe Withdrawal Rate.

With a dividend based strategy, you avoid selling any shares. This protects you against bankruptcy. Dividends provide a continuing income stream.

Dividends are tightly related to (smoothed) earnings. As a rule, today’s dividends are well covered. The payout ratio of the S&P500 is low.

Prices are only loosely related to earnings. They reflect investor hopes and expectations. Price volatility is much higher than dividend volatility. Despite recent price drops, today’s valuations are exceedingly high by historical standards.

Dividend cuts do happen. The historical extreme of the S&P500 index since 1950 was a reduction of buying power by 25% (to 75% of the real dividend amount). Today’s dividend cuts by a few financial firms is unpleasant, but not a total disaster in a reasonably diversified portfolio. The corresponding price cuts are worse.

Determining dividend quality is much easier than evaluating the potential for capital appreciation. Monitoring dividend based strategies is much easier during retirement than monitoring the safety of capital appreciation strategies. Yet, some people assert that, because dividend cuts are possible, dividend based strategies are worthless. Nothing could be farther from the truth.

Have fun.

John Walter Russell
March 11, 2008