Remember the interesting conversation we had about dividend investing?
I discussed my plan to retire without spending any of the capital I've accumulated (I want a retirement where I can simply live off the earnings of my assets without decreasing the principal). I mentioned that dividend investing, along with real estate, could be a possible way to reach my goal.
Shortly after that piece posted, a reader sent me this piece that lists three reasons dividend stocks tend to outperform non-dividend stocks. The reasons:
1. Dividend Stocks Often Have Higher Quality Earnings Because You Can't Fake Cash
2. Dividend Yields Can Support a Stock During a Market Crash
3. Dividend Policies Put Pressure on Management to Be More Selective About Uses of Shareholder Capital
These are good points and worthy of consideration. But then the same reader sent me an even more interesting article on dividend investing, this one from someone who I admire and respect, Jonathan Clements at the Wall Street Journal. Here are some highlights he lists for using dividend investing in retirement. It begins with the same goal I'm looking for in retirement:
It's OK to spend your income, but never, ever dip into capital. Remember that old financial commandment? It was discarded long ago as a fuddy-duddy rule that doesn't work in our low-yield world. But as I ponder retirement, focusing on dividend-paying stocks, so you don't have to dip so often into capital, looks better and better— for seven reasons.
He then lists his seven reasons as follows:
- Low bond yields.
- Less risk. If you needed to create your own dividends, you could have found yourself selling stocks at deeply depressed prices. By contrast, dividends aren't nearly as volatile as share prices.
- Inflation protection.
- Intriguing funds.
- Favorable tax treatment.
- Value effect. Research suggests that bargain-priced value stocks have, over the long haul, outperformed fast-expanding growth stocks. High-dividend stocks are usually value stocks, so they could perform better than average if the value effect persists.
- More discipline. Companies are quick to halt buyback programs when their finances get tight, whereas they're loath to cut dividends. Indeed, paying a large, regular dividend provides managers with a healthy dose of discipline and forces them to think more carefully about how they spend the company's remaining cash.
He then ends with the following:
This isn't to say you should bet your retirement solely on high-dividend stocks. The financial world is too uncertain for that. But tilting toward high-dividend stocks deserves a place alongside other retirement-income strategies, including delaying Social Security, annuitizing a portion of your savings and holding a hefty cash reserve.
If you're collecting 3% in dividends and your goal is the often-recommended 4% portfolio withdrawal rate, you will need to augment your retirement income by dipping a little into capital and doing some occasional selling. But thanks to the dividends, you won't have to do much selling—which means you can watch those stock-market swings with far greater equanimity, while you wait for your next dividend check to arrive.
Exactly. This is exactly what I was thinking when I wrote the original post. It was just that Jonathan was much better at explaining it than I was.
This strategy could be added to the others that I detailed in my retirement budget to help me retire and live (rather easily) off the earnings of my assets, not having to spend the assets themselves.
What do you think?