When I look to add dividend-paying stocks to my retirement portfolio I always look for companies that have a long history of paying dividends as well as a history of solid growth in those dividends. It's even better if the company has shown it can weather recessions by not cutting its dividend when the economy goes south.
One of my favorite stocks that fits this bill is Wal-Mart (WMT). Wal-Mart has averaged nearly 13% growth in its dividend over the past five years. Wal-Mart's one-year dividend growth rate is 9%. During the recession in 2008/2009, Wal-Mart actually increased its dividend by 24%, which is amazing given that many people consider it a somewhat cyclical company.
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 Wal-Mart, 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 Wal-Mart 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 (JNJ), Coca-Cola (KO), Intel (INTC), 3M (MMM), Chevron (CVX), Procter & Gamble (PG), and Exxon (XOM).
What I want to show today is how a dividend-paying stock like Wal-Mart 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 3.7%. 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 $160,000 if we reduce everything by the inflation rate. That is only 1.3% per year in after-tax real terms. I plugged in these numbers into our Retirement Planner and found that this couple would only have a 25% 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 Wal-Mart. 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 Wal-Mart.
In this example I assumed a dividend yield of 2.6% (Wal-Mart's current dividend yield), long-term annual dividend growth of 9%, 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 nearly $800,000 (in today's dollar terms) when they retire. Plugging these numbers into our Retirement Planner I found that they now have an 80% 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. If we assume the price of the stock increases by just 2% per year over this time frame the ending real value of the account is over $1.1 million and the probability of never running out of money in retirement jumps up to over 90%.
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.