A few years back, financial services company ING ran a television commercial featuring individuals toting around big, orange numbers. "Your number ... every person has one," the narrator said. "But what is it? It's what you'll need to have saved to retire the way you want."
A bicyclist pedaled along with $1,269,407 under his arm. A woman carried $675,423 while she walked. A guy in an airport security line placed $2,184,627 onto the belt to go through the X-ray machine. A businessman in an expensive suit held $2,654,712 as he ambled confidently down a city sidewalk.
Hiring a firm such as ING to calculate a precise number of dollars to last through 20 or 30 or 40 years of retirement is how many investors get started in Modern Portfolio Theory: Save X dollars in stocks and X dollars in bonds through your working years; invest more conservatively as you near the end of your career; retire; spend about 4% of your money per year on food, shelter, health care, entertainment, family events, etc.; die, leaving the remainder (if any) to your heirs.
Well, my wife and I do have a number, and we doubt ING would approve: $25,000.
Twenty-five grand? Who can live on $25,000? Come on!
Although the Employee Benefit Research Institute recently said 57% of all workers in the United States have less than $25,000 in total savings and investments -- including 28% who have less than $1,000! -- I think most of us here would agree that $25K is a preposterously low figure.
Thankfully, when I say $25,000 is "Our Number," I'm not talking about the dollars Roberta and I will take into retirement. I'm talking about the amount of dividend income we want to have streaming into our accounts by the end of next year. That will represent the first leg on our path to worry-free retirement.
That's right, friends, the road to Fat City is paved by Dividend Growth Investing.
Once we reach the point where the companies we own are kicking off $25K in annual dividends, it means we will be only about five years from $36,000 in dividend income. I decided when we adopted the DGI strategy 18 months ago that $3,000 per month would be a satisfactory complement to the Social Security and pension payments we will receive.
The following table shows how $25,000 in annual dividends can grow if reinvested back into the portfolio. I assume a 5.5% dividend growth rate, 3% overall portfolio yield and 4% inflation.
|YEAR||DIVIDENDS||DIV GROWTH||NEW DIVS||INFLATION|
(Key: DIVIDENDS are annual dividends generated by investments; DIV GROWTH is money generated by growth of dividends each year; NEW DIVS represent new assets purchased by reinvested dividends; INFLATION indicates each year's equivalent in today's dollars to the annual dividend goal of $36,000. Special thanks to ScottU, who regularly comments on Seeking Alpha articles relating to DGI, for creating this table for me.)
Four Fun Facts
Assuming my wife and I reach $25,000 in dividend income next year ...
1. In 2019, our investments will generate $37,591 in dividends, including $2,068 produced by dividend growth alone and $1,128 by growth of reinvested dividends. (Although that is more than our $36,000 goal, we will need $43,800 in today's dollars in 2019 to equal $36K at a 4% annual inflation rate.)
2. By the end of 2023, when we both will be eligible for Social Security, our portfolio will generate enough dividend income to exceed the inflation-adjusted $36,000 goal.
3. In 2031, the year I will have to start taking required minimum distributions (RMDs) from my traditional IRAs, we will have eclipsed $100K in annual dividends received.
4. By the time I turn 80 in 2040, our annual dividend income will exceed $208K. Even in inflation-adjusted dollars, that will nearly triple our original $36K goal ... and you'll be seeing one spry octogenarian kicking his heels in celebration!
Five Big Questions
Now, here are five potential potholes in our DGI road to Fat City:
1. What if we fail to create a portfolio that will generate $25,000 by the end of 2014?
Doubtful. We are more than 75% there, we still have cash to invest, and Roberta's 401k just added a brokerage option. We already have taken advantage of the latter factor by adding to our McDonald's (NYSE:MCD) position. Even those who dislike Big Macs and Egg McMuffins must admit that McDivvies sure are tasty!
2. What happens when RMDs rear their ugly heads?
I'm not going to lie -- I'm not thrilled about being legally obligated to take distributions from traditional IRAs. Before I get to 70 1/2, we might convert many of those accounts to Roth IRAs, which are not subject to RMDs. Or, once we start making our required RMDs, we might use the distributions to buy DGI companies in our taxable accounts. Bottom line: If we don't actually need to live on all of the distributions, we will find ways to earn more dividends.
3. What if our assumptions about DGR, yield and inflation are wrong?
If anything, I erred on the side of caution. Our portfolio, the subject of my recent four-part series about our flight to quality -- read Part 4 here -- has a DGR much better than 5.5% and a yield closer to 4% than 3%. There is no reason to expect anything less for the next several decades. Plus, inflation hasn't hit 4% for years; it's about half that now. Add in the fact that we will be investing new money into DGI stocks for the next several years, and we probably will arrive at milestones far earlier than projected.
4. What if Congress changes the rules on Roth IRAs and other investment vehicles?
Could it happen? Sure. Will it happen? I don't know. Neither do you. And neither do economists, soothsayers or politicians. I'm not about to start making investment decisions based on conjecture about what might happen three years or three decades from now. All I can do is take advantage of the rules as we know them.
5. What if we have to stop reinvesting dividends once we retire because we need them to support our lifestyle -- not to mention to feed us, clothe us and keep a roof over our heads? Won't that slow the growth of dividends within our portfolio?
The answer to that last question is yes. If we have to spend our dividends instead of reinvest them, we will lose that part of the compounding effect.
Still, the continued dividend growth, even without reinvesting divvies, will result in compounding. Also, a significant chunk of our retirement income will come from Social Security, pensions and non-stock holdings, so we very well might be able to continue reinvesting some of our dividends.
And remember: One cost that decreases substantially for most retirees is ...
THE COST OF INVESTING!
My wife maxes out her 401k, including catch-up contributions. I put 125% of the earnings from my freelance work into my Individual 401k. And we both put the maximum into our Roth IRAs. Though we're far from rich -- neither of us has had a six-figure salary, and I have been semi-retired since I was 48 -- we have been investing as much as possible for years, and we plan to continue doing so.
That's tens of thousands of dollars annually -- by far our biggest "expense." When we're no longer working, those investment costs will be zero or close to it. With our home paid off, Social Security payments coming in and a healthy dividend stream topping it all off, I actually believe we will have considerably more money available in retirement.
One Final Question
One question I didn't ask earlier: What if we panic and sell during the next deep recession or the one after that?
Answer: We won't ... and the dividends will keep rolling in.
In June 2008, we bought 3M (NYSE:MMM), Procter & Gamble (NYSE:PG) and a few other companies. We didn't panic when the economy tanked. Indeed, we added to our stakes at lower prices by making regular purchases and reinvesting dividends. I like to think we'd do the same during recessions to come.
A Modern Portfolio Theory investor can be crushed by an economic crisis, as his or her "number" gets slashed by a third, a half or more. Suddenly, that unfortunate soul is drawing down 4% of his or her severely bruised portfolio, selling investments at exactly the wrong time.
One of the great things about DGI is this: If we invest in high-quality companies with a history of increasing dividends through even the darkest financial times, we will go to bed each night confident the distributions will continue. And thanks to that reliable, growing income stream, we will not have to sell off 4% of our portfolio every year.
This is fact, not theory. It is a pragmatic plan, not a high-risk scheme. Our portfolio is filled with the likes of Coca-Cola (NYSE:KO), Chevron (NYSE:CVX), Philip Morris (NYSE:PM) and Johnson & Johnson (NYSE:JNJ). These are household names, true blue-chippers that have grown dividends through wars and recessions and political silliness. There is no logical reason to believe the next financial crisis will make these companies change decades-old philosophies.
We want to create as much wealth as we can, sure, but not by reaching some arbitrary number that might or might not last us a lifetime. We don't want to draw down 4% of what we own every year. We never want to touch our principal ... and with Dividend Growth Investing, we shouldn't have to.
By this time next year, and possibly quite a bit sooner, we'll have reached our number -- $25,000 in dividends. We'll be well on our way down the road to Fat City.
And if a couple of regular folks like us can get there, so can you.