Not so long ago, many workers could count on a comfortable retirement, courtesy of a defined benefit pension plan provided by their corporate or government employers. Today, not so much.
From 1980 through 2008, the proportion of private wage and salary workers participating in traditional defined benefit pension plans fell from 38 percent to 20 percent (Bureau of Labor Statistics 2008; Department of Labor 2002). In contrast, the percentage of workers covered by a defined contribution (DC) pension plan - that is, an investment account established and often subsidized by employers, but owned and controlled by employees - has been increasing over time. From 1980 through 2008, the proportion of private wage and salary workers participating in only DC pension plans increased from 8 percent to 31 percent (Bureau of Labor Statistics 2008; Department of Labor 2002).
In the last several years, many rules have been changed in the middle of the game for baby boomers and additional proposals have been made that will have a large impact on the retirement income of baby boomers.
- Social security benefits became taxable on a means tested basis in 1983. In 1981 the National Commission on Social Security Reform (sometimes referred to as the Greenspan Commission after its Chairman) was appointed by Congress and President Reagan to work on the financing crisis in Social Security. The result of their study included several amendments that were passed by Congress, signed by President Reagan and made into law in 1983. Today, higher income individuals will pay taxes on 85% of their Social Security benefit income.
- The age to receive the full social security benefit was raised from 65 to 66 and 67 based on the year you were born, and there is a proposal to raise it further, to age 70.
- A Medicare surcharge of 3.8% has been imposed on high earners. Additionally, wages above $200,000 (individuals) and $250,000 (joint filers) will be subject to higher payroll taxes.
- The federal government has just proposed limiting the amount you can contribute to your IRA account or 401k to about $3 million. After that amount, you will no longer be able to deduct further contributions on your tax return to shield them from current taxation. Of course, this will reduce the attractiveness and tax benefit of saving for retirement, while raising tax revenue in the process.
- There are proposals to means-test Social Security benefits. This means that the benefits you are "allowed" to receive will be determined by your income and assets in retirement. In other words, the government is proposing to decide whether or not to pay out any Social Security payments to you, and if so, how much, based on how responsible you have been throughout your working life. The more you have invested and saved to prepare for your own needs in retirement, the less the government will pay out, from the Social Security taxes you've contributed all those years.
The writing is on the wall. Since the Social Security program is trending daily from a supplemental retirement program towards a means-tested welfare program, you have two choices: either spend down all your savings before retirement to qualify for full social security benefits and resign yourself to living your final years in poverty, or save and invest like crazy to overcome all of these obstacles and be responsible for your own comfort and security.
Many corporations are closing long-established defined benefit pension plans. They were simply not successful in building enough assets to provide for the promised pensions of future retirees. So, for most of us there will no longer be a corporate or government back-stop. We must prepare for ourselves.
This is not your father's retirement plan
Here is the good news! You can do it on your own by combining dividend growth investing (DGI) with high yield dividends and opportunistic investing.
DGI need not be boring. If you crave the action, you can be as actively engaged as a trader by deploying some powerful strategies. You can juice your returns and retirement income by overlaying several strategies.
Bombs are dropped on individual portfolio holdings on a regular basis. Investors have several choices in how they wish to react.
A. They can react like deer, frozen in the headlights and do nothing.
B. They can panic, hit the sell button and dump their position, or
C. They can seize the opportunity and buy when others are frozen or panicked.
I always choose C.
Panic selling implies irrational fears are leading investors to sell their assets for less than they are truly worth. If you seize this opportunity, this virtually guarantees you are buying cheaply on sale.
If you are running a dividend growth portfolio, you will always be generating income which serves as ready, fresh powder that you can direct into new investments, or add shares to existing positions when opportunities present themselves.
Here are some panic situations that you can profit from:
1. Secondary announcement sell-offs. REITs, MLPs, and BDCs, many of which have solid, high dividend yields, routinely float secondary share issues to raise capital to pay off debt or expand their businesses. It is very common for investors to panic on these announcements, surmising that such an issuance represents dilution to their share positions and determining, wrongly, that it will negatively impact the stock price. This very panic is a self-fulfilling prophecy that usually leads to a temporary correction of 5% or more to a stock's price.
The knowledgeable investors seizes this opportunity, buys more stock on the cheap that is being dumped, thereby averaging down his original cost, increasing his dividend yield and dividend income, all at the same time.
2. Buy on company specific events that only temporarily impact your stock's price.
Netflix Gets Flicked Off by Investors
Netflix (NFLX) is a good example. When chairman Reed Hastings decided to change pricing and membership plans by separating DVD mail rental service from the instant streaming of movies online, a firestorm erupted among Netflix members and shareholders alike. The stock price tanked, in this panic, from a high of $298.73 to a low of $53.91 for a retreat of an astounding 82%.
Investors who understood that Netflix was the leader in the home video rental industry and had first player's advantage, a large and growing subscriber base and intentions to expand its successful service internationally, were able to assess the situation properly. They could see this as an over-emotional, irrational reaction to a temporary situation and take advantage of the blood in the streets, loading up on the shares.
Any investor alert enough to scoop up the "trash" of the panicked crowd anywhere around the $53.91 low would have turned these shares into a veritable treasure at today's price of $224.30, more than a 4-bagger.
Green Mountain Gets Roasted
Green Mountain Coffee Roasters (GMCR) is another recent example of company specific negative impact on a stock's price. Hedge fund manager David Einhorn of Greenlight Capital made an impassioned pitch at a high profile investor conference in New York City last year. He utterly trashed the company, attacking its accounting and inventory practices and went on to make a very strong short case. Green Mountain stock went into a tail-spin, from a high of $111.62 to a low of $17.56 in less than a year's time. This was a fall of 84%.
The astute investor was aware that Green Mountain was a strong, innovative company in business for over 30 years that created the finest coffees and bought out many of its major coffee suppliers. It later bought the Keurig Company, developed and successfully spread the concept of individual servings for the home and office, continuing to enlist over 200 major partners including Starbucks (SBUX) and Dunkin' Donuts (DNKN). To deal with its expiring patent on K-cups which was the basis of investor's fears and a major part of Einhorn's attack, Green Mountain developed another coffee brewer called the Vue, with its own distinctive, patented coffee delivery pod. The Vue offers over 60 different kinds of coffees, including regular, espresso, café latte, teas, cold and hot, hot chocolate, and the count is constantly expanding.
Green Mountain's stock has since rocketed from the low of $17.56 to $57.06 today, awarding a more than triple bagger to the investor who turned this "trash" into treasure.
3. Buy on Flash Crashes. Yesterday, the Dow crashed 145 points in just 3 minutes time on a panic started by a false tweet. The Associated Press's twitter account had been hijacked. The tweet falsely stated that the White House had been attacked and that President Obama had been injured. While this "bomb" had been dropped on the stock markets of the world, investors panicked, dumped stocks, and many situations in the marketplace presented temporary discounts of 4-6%.
As soon as the AP announced its account had been hijacked and that no attack had in fact taken place, the mini flash crash was stopped in its tracks and the Dow rose 152 points in minutes, awarding several percent in profits to investors quick on the draw and on the hunt.
20 Minute Pay-Day
The flash crash of May 6, 2010 saw the Dow plunge 1010 points, or 9%, over about a 20 minute period, only to recover those losses in just minutes. A recent report has put some of the blame on a brokerage house's algorithmic trading system that looked primarily at large volume increases without regard to other major factors in the marketplace.
Investors paying attention to this huge seismic event had a once-in-a-lifetime opportunity to scoop up quality names that had been dumped at fire-sale prices by panicked investors and saw their efforts rewarded by gains of 10 to 15 percent in many stocks, all in 20 minutes time.
4. Buy additional shares in corrections and bear markets: use accumulated dividends.
This tactic results in a decreasing average cost per share and increases your dividend yield and dividend income, all at the same time. When recessions develop and stock prices go into free-fall, they present the dividend investor with an ever-cheaper pricing opportunity. While other investors are getting margin calls, they are forced to sell even their highest quality stocks at steeply decreasing prices. As mutual fund managers receive greater numbers of redemption requests from share owners, they too are forced to liquidate their portfolios to raise cash to meet redemptions. Hedge fund managers face the same pressures from their investors who are panicking and want their money back as soon as possible. These managers must all liquidate growing amounts of stock to satisfy all the redemption requests.
Back up the truck when everyone else is selling
All of these actions create a whirlwind of irrational, forced selling. If you are a dividend investor with 30-40 names in your portfolio, you could have around 120-160 dividend paydays per year (4 quarterly payments per stock per year), more if you own any monthly payers. This presents the astute investor with the wherewithal and buying power to step up and take other people's "trash" and turn it into their own treasure. Inevitably, many stocks become accidental high-yielders in these severe down-turns. Most good quality dividend companies maintain their dividends, or even raise them through recessions. Since their stock prices have come down, their dividend yield increases dramatically.
Investors hang up on AT&T
A stalwart like AT&T (T) was paying a dividend of $1.42 in January 2007 while it traded at $37.63, very close to today's price. Its yield at that time was 3.77%. By the time the AT&T hit bottom on March 2, 2009 its stock hit a low of $21.44. It continued, however, raising the dividend throughout the crash, to $1.64.
The investor who recognized this bargain was able to buy this amazing cash cow for $21.44, receive a $1.64 annual dividend and earn an accidentally high yield of 7.65%. He would also have a huge capital gain on $17.56 per share as of a few days ago, or 82%. And the company has continued to increase the dividend. It is now $1.80 per share, for a yield-on-cost for this investor of a whopping 8.4%.
5. Sell Covered Calls to enhance your dividend income
Grant to other investors the right to buy your shares at some point in the future at a higher, out of the money price. This investor will pay you a premium for this privilege. You earn this premium the moment you sell the call. This gives you more firepower in your portfolio to buy more dividend paying stock and increase your income once again. Please read my recent articles illustrating this strategy using REITs, including American Capital Agency Corp. (AGNC), Annaly Capital Management, Inc. (NLY), Hatteras Financial Corp (HTS), and fast food, consumer staples companies, including McDonald's Corporation (MCD), Wendy's (WEN), and Burger King Worldwide, Inc. (BKW).
Too many investors are still frozen in fear, burned from exposure to two large crashes in the last decade. These investors panicked and sold all their stocks at the bottom in March 2009 at artificially reduced prices. Now, they mistakenly think that they need every dime of their savings available to them on the very day they retire. So they keep all of their savings in cash, or cash equivalents, earning nothing.
The opportunity cost of doing nothing is earning zero, minus the rate of inflation; in other words, a negative return on your money. While they sit on the sidelines with huge piles of cash, their $100 in the bank will have less than $80 in buying power in ten short years ($70 or less if you don't quite buy the government's official inflation figures). If you tried to explain to them that the same $100 would retain buying power of less than $40 by the time they were ready to retire in 30 years, they'd think you were crazy. Well, remember when a coke cost a nickel? When a movie theater admission cost 25 cents? When gas cost 25 cents a gallon?
Deploy some of the discussed strategies and you'll be able to stay ahead of inflation with an ever-increasing stream of dividend income. Buy The Coca-Cola Company (KO), Regal Entertainment Group (RGC) and ConocoPhillips (COP) and when you reach retirement you'll be able to buy as much coke, movie tickets and gasoline as your heart desires, for you and your grandchildren.