We've heard the problems again and again: interest rates are too low, savings aren't enough, and too many people lost too much wealth over the past five years to be able to retire before they're 70.
Because of the issues I just cited, along with many others, more than half of those approaching retirement fear that they will run out of money. Because of this we have a record number of people in this country working into their 70s. There are also more people than ever before that have cut their expenses to the bone, moved in with their children, or have sold their home and moved into a low-cost apartment just so they are sure they won't run out of money.
Needless to say, this isn't the dream retirement that so many people had. Not only is this a tough state of affairs to be in, but the whole situation was likely entirely preventable for many of them.
A large part of the problem for many of those approaching retirement is that they either a) Invested way too heavily in low-yielding treasuries or money markets, b) They had most or all of their money in stocks during the crash of 2008/2009 and then pulled their money out near the lows, or c) Many people assumed they would sell their house (at house bubble prices) or use it as a cash machine by taking out equity and spending those funds in retirement.
This article is not going to recommend that people invest heavily in stock funds or ETFs for the rest of their lives. This strategy has gotten too many people into way too much trouble over the past 15 years. What I want to discuss today is how carefully selecting and investing in strong dividend paying stocks, such as Johnson & Johnson (NYSE:JNJ) can pay off big time in the long run and reduce stress immensely as movements in the stock price eventually barely matter.
Although I will focus on Johnson & Johnson in this discussion, the strategy here applies to many companies that have a solid history of increasing (or at least not cutting) their dividends over time, even during recessions. Other companies that fit this mold are Procter & Gamble (NYSE:PNG), Coca-Cola (NYSE:KO), Exxon (NYSE:XOM), and Wal-Mart (NYSE:WMT).
Let's take a look at what makes companies such as Johnson & Johnson such a solid investment for retirement portfolios.
Not only does Johnson & Johnson have a strong dividend yield of 3.2%, but its dividend has been growing at a solid rate of over 9% over the past five years. Its payout ratio is relatively low at 62%, which leaves even more room to grow its dividend over time. And perhaps the most amazing statistic is its dividend growth rate during the painful recession of 2008-2009. Even in this environment it was able to grow its dividend by 18%.
What I want to show today is how a dividend paying stock like Johnson & Johnson can change a person's entire retirement situation. I want to take a look at a 45 year-old couple that has been scared out of the stock market and currently has everything invested in long-term treasury bonds at 2.8%. They currently have $400,000 saved. Let's also apply an inflation rate of 2% for each year. They plan on retiring when they are 65. How much money can they expect to have when they retire if we take into account inflation? For this example I assumed half of their money was in a qualified, non-taxable account such as an IRA. They pay taxes at a 30% rate on their investment income and dividends are taxed at a 15% rate.
Here are the results for this couple if they keep all of their money invested in low-yielding treasuries:
Real Annual Return After Taxes
In 20 years their investments have only grown by a mere $45,890 if we reduce everything by the inflation rate. That is only 0.57% per year in real terms. I plugged in these numbers into our Retirement Planner and found that this couple would only have a 15% chance of not running out of money if they save $10,000 a year for the next 20 years, spend $45,000 a year in retirement and receive $35,000 a year in social security payments. This couple is headed for serious trouble.
Now let's look at the case where they invest in a basket of solid dividend payers such as Johnson & Johnson. It is important to note that I am not recommending investing in just one stock. I am recommending investing in a basket of solid dividend paying stocks that have characteristics similar to Johnson & Johnson.
In this example I assumed a dividend yield of 3.2%, long-term dividend growth of 7.5%, and no increase in the stock price at all. I ran these numbers in our free online calculator called Dividend Yield And Growth.
Real Annual Return After Taxes
Now we're talking some real money when they retire. They will have over $730,000 (in today's dollar terms) when they retire. Plugging these numbers into our Retirement Planner I found that they now have a 70% chance of never running out of money in retirement. It is important to keep in mind that I assumed no change in the stock price in this example. I wanted to show how just collecting the dividends from strong dividend growth stocks can have such a large impact.
Because of the time factor involved with dividend growth stocks it is of utmost importance to begin investing wisely when you're relatively young. For those who are already in their 60s this strategy will not be as useful, although it can still be a significant part of their overall strategy.
Disclosure: I am long JNJ, KO, WMT, XOM, PG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.