With both stocks and bonds gyrating wildly again many of us are reminded of just how volatile the markets can become. This also convinces many people that they cannot risk being invested very heavily in equities as they approach retirement.
But without a decent return, many people simply will not be able to retire when they want to. In fact, many people will run out of money in retirement.
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 or 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.
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 dividend paying stocks that will have solid dividend growth for the next 20 years, such as Apple (NASDAQ:AAPL), can pay off big time in the long-run and reduce stress immensely as movements in the stock price eventually barely matter.
With the recent large drop in Apple's share price, its dividend now yields a respectable 3%. Add to this the fact that they just increased their dividend by 15% over a three month period.
Although I will focus on Apple 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 Johnson & Johnson (NYSE:JNJ), Coca-Cola (NYSE:KO), Exxon (NYSE:XOM), and Wal-Mart (NYSE:WMT).
One thing to keep in mind is that Apple only just recently began paying a dividend again so we do not have much recent history on their dividend payments. But my view is that they will continue to increase their dividend by double-digits for years to come as they have the cash on hand ($137 billion) to do it as well as the net income.
What I want to show today is how a dividend paying stock like Apple 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 2.9%. 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 $55,890 if we reduce everything by the inflation rate. That is only 0.60% per year in real terms. I plugged in these numbers into our Retirement Planner and found that this couple would only have a 17% 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 Apple. 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 Apple.
In this example, I assumed a dividend yield of 3%, long-term annual dividend growth of 15%, 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 $800,000 (in today's dollar terms) when they retire. Plugging these numbers into our Retirement Planner, I found that they now have an 85% 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 XOM, WMT, JNJ, KO. 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.