Retiree Needs

A retiree needs a steady income stream that grows faster than inflation. He needs an income stream that is isolated from the whims of the market. He needs income that lasts indefinitely.

Dividend based strategies satisfy this need.

Dividend Strategies

A retiree can start out withdrawing more than the prevailing dividend yield. He can augment his income in the early years by liquidating a TIPS ladder.

The S&P500 index currently yields 1.8%. My most recent investigation shows that today’s retiree can plan on a dividend growth 2.8% per year (plus inflation) even when using the S&P500 index.

A careful investor can do much better. He can get a higher initial dividend yield simply by limiting his purchases to dividend paying stocks. He can enhance dividend growth by paying attention to what he buys. He needs to focus on the attitude of corporate management towards dividends and the quality of the underlying earnings.

A careful investor gains a tremendous advantage by paying attention to prices. Simply using limit orders dramatically improves returns. A careful investor can exploit the fantastic buying opportunities that are likely to show up within the next ten to twelve years if he keeps some cash on hand. There will be a few great opportunities even in the next four or five years.

Conventional Strategies

Contrast dividend strategies to conventional strategies.

Conventional strategies do a horrible job of satisfying retiree needs.

Conventional advice is focuses on single-year returns. Only through short-term focus would any investigator ever interpret market prices as fair prices, accurately reflecting value. Today’s advice ignores valuations, which is insane.

Conventional approaches liquidate stocks, which limits a portfolio’s life. Liquidating stocks can make sense when valuations are low. Price increases can add a tremendous boost even at normal valuations. Liquidating stocks when starting at today’s high valuations leads directly to bankruptcy.

Dividend Growth

An initial dividend yield of 4% that grows at 3% per year ends up yielding 5.36% of the initial investment after ten years. An initial dividend yield of 3% that grows at 6% per year ends up yielding 5.37% of the initial investment after ten years. Both combinations are reasonable.

Using a spreadsheet and assuming a portfolio of 50% stocks and 50% TIPS at a 2% (real) interest rate AND NEVER REBALANCING, I found that:

1) You can withdraw 5.6% of your original balance (plus inflation) indefinitely IF your initial dividend yield is 3% and your dividend growth rate is 6% per year (real).

2) You can withdraw 5.2% of your original balance (plus inflation) indefinitely IF your initial dividend yield is 4% and your dividend growth rate is 3% per year (real).

3) You can withdraw 5.7% of your original balance (plus inflation) indefinitely IF your initial dividend yield is 4% and your dividend growth rate is 4% per year (real).

Nominal growth rates must be about 3% higher because of inflation.

Satisfying Needs

We can increase retirement income dramatically by focusing on dividends and dividend growth and by augmenting income in the early years with a TIPS ladder. We should be able to achieve continual income streams of at least 5.2% of the original balance (plus inflation) even in today’s market.

Contrast this to the 4% (inaccurately) claimed for conventional approaches.

Have fun.

John Walter Russell
January 18, 2007