It is one of the most common questions that people in the workforce ask themselves: How much will I need to save in order to retire comfortably? The problem is that this crucial question is not easy to answer. The required amount will be influenced by many factors. For example, how much income will be needed annually to maintain a desired lifestyle?
When I think about retirement, I don't worry about the amount of savings that I would like, but instead the annual income that I will need. I would ideally like my assets to be generating more income than what my predicted needs will be. This way I can continue to increase my income stream through reinvestment while never having to decrease capital. I believe that the best way to do this is through a dividend growth stock portfolio
If I believe that I want to retire with an annual income stream of $50,000 in today's purchasing power, then I can figure out my target amount for this retirement dividend portfolio. By taking into account years until retirement, inflation, and expected dividend yield, I can calculate my number. The formula for this would be as follows:
Future Amount Needed = ((Current Income Desired) x (1 + Inflation Rate) ^ (Years until Retirement)) / (Expected Dividend Yield)
For example, a 35-year old investor seeking $50,000 annually in today's purchasing power 30 years down the road assumes a 2% inflation rate and expects to receive a average 4% dividend yield from his portfolio. This would translate to:
($50,000 x 1.02^30)/.04 = $2.26 million
Although at first this amount might seem unattainable, it is actually well within reach for a disciplined saver and investor. Starting with $50,000 savings at age 35, combined with annual deposits of $10,000 and historically average returns at about 9%, an investor would accumulate over $2 million by retirement. Everyone's savings plans will be different, but the important thing is to start as early as possible and to keep focus on the long-term plan.
Let's take a look at a small portfolio of quality retirement dividend stocks that could help the investor achieve an average 4% yield.
Intel Corporation (INTC) - Intel is a $100 billion company in the semiconductor chip industry. Struggling recently due to a declining PC industry, Intel now offers a 3.7%% current yield. The payout has increased from $0.56 per share in 2009 to the current dividend of $0.90, making it a high dividend growth stock. High current yield combined with a low payout ratio and solid dividend growth make Intel a solid long-term pick. Current prices offer an attractive entry point as valuation has suffered due to weakness in the PC market. Look for Intel to make a push into mobile and adapt to the changing industry.
Lockheed Martin Corporation (LMT) - A $28 billion security and aerospace company, LMT has raised its dividend for the past decade and currently pays out 4.3%. Combine this with a EPS payout ratio of only 55% and annual dividend growth of 20% over the past five years, and LMT's future prospects look very promising. The current P/E ratio around 12 is about in line with historical averages, implying that the stock is fairly valued at current levels. Despite Defense Budget concerns, I believe LMT will continue to perform well due to its wide range of products in high demand. Even after the recent increase in price, I expect LMT to continue to perform well and reward shareholders.
Phillip Morris International (PM) - Philip Morris is a large-cap ($148 billion) international manufacturer of cigarettes and other tobacco products that currently yields 3.6%. Its portfolio of products includes the dominant Marlboro brand. Since its spin-off from Altria (MO) in 2008, PM has provided enormous amounts of shareholder value through dividend increases and aggressive stock buybacks. Outstanding share count has decreased by over 20% since the spin-off, from over 2 billion to 1.65 billion. PM also announced a three-year, $18 billion share repurchase plan this past June. This will ensure that earnings per share rise at an even faster rate than total revenues and allow for more dividend growth. The main threat here is litigation, although PM's international exposure limits this risk substantially, as compared with the strictly domestic MO.
AT&T, Inc. (T) AT&T is the largest U.S. telecom stock with a current market cap of about $200 billion, about one and one half times that of its largest competitor, Verizon Communications (VZ). Together, these two industry giants make up more than two-thirds of the U.S. wireless telecommunications market, a virtual duopoly. AT&T provides wireless services to over 100 million subscribers, all of whom pay monthly fees for wireless coverage. This telecom giant has paid and raised its dividend annually for the past 30 years and is currently yielding 4.8%. With earnings per share of $1.25 and a dividend of $1.80, T seems to have payout ratio of almost 150%. Since a company needs to earn enough to cover the dividend payment, this ratio might initially look to be very high and difficult to sustain going forward. However, this number is misleading because of factors including depreciation and one-time expenses such as the recent actuarial loss in its pension fund. If we look a little closer at the free cash flows of AT&T, we see that it is generating plenty of cash to continue its payout. The dividend does not seem to be in any danger going forward.
I believe all of these companies would make solid long-term investments for anybody trying to create their own dividend growth portfolio for retirement. Although these are not enough to be diversified, they can create a solid foundation for any portfolio.