How Much Dividend Income Growth Do You Need?

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Includes: ARCC, EPD, HTGC, MWE, O, OHI, VNR
by: Factoids

This is an article for old folks like me that invest in dividend and distribution paying stocks like Realty Income Corporation (NYSE:O), Enterprise Products Partners (NYSE:EPD) and Ares Capital Corporation (NASDAQ:ARCC). It is about investing for income in the here and now. It is for investors who strongly believe that they can do better than the standard plan of putting all their money into mutual funds; starting retirement with a 4% withdrawal rate per year; growing the withdrawal rate as inflation grows; and accepting the odds that there is only an 85% chance that your money will not run out before you die. Even if the portfolio does not run out, it will be seriously depleted by time. I want to create an individual stock portfolio that begins with more than a 4% payout (or in this case - yield); grows that payout faster than inflation via dividend growth; and has that growing flow last till I die without ever touching the original capital. The difference between those two plans is huge in the here and now - and should be huge for the next two generations of your heirs. I will still own some mutual funds for diversification. But the majority of my portfolio has been and will be in well chosen individual stocks.

For the duration of this article, I need you to accept these three premises (and then promptly throw those premises away) - (1) "There are no bad stocks, there are only bad portfolios." This article is not about stock selection. It is about portfolio building. The second premise is equally untrue. Investing is really a circular process. But you have to jump into that process somewhere. For the purposes of this article, I will say that (2) "Retirement (or income) investing starts with knowing your portfolios' dividend growth CAGR (or compound annual growth rate)." I strongly believe that you need to know where your portfolio is headed - and then determine if you need to change its course. I strongly suspect that many of you do not know where your portfolio is headed. If you are one of the many, you need to change. The third premise is that (3) you can use five-year CAGR projections as 20-year projections. That is not true, but that is what I have done with this data. When the CAGR projections substantially change (and I hope you know to gather your projections from a number of sources - and not do a backward looking "calculation"), then the portfolio needs to change. That is a stock selection issue. This article also fails to give any mention to the level of risk in any investment. You cannot ignore risk in stock selection. And I personally want a portfolio that is heavy in lower-risk investments.
This article will start with a relatively short section on how much growth you need. The middle will be long and full with data to juggle on portfolio components. I have cut the number of portfolio components in the sample portfolios to an unrealistically low number of ten. A portfolio of ten components might be OK if individual stocks were only 20% of one's portfolio. But ten is the maximum that I want to juggle at one time. And these portfolios were made to illustrate the points I will try to make in this article. None of these insufficiently diversified portfolios of ten is one I would want you to copy with a high percentage of your money. I will end with a very short summary, a few conclusions and one request.

How much growth do you need?

From the Study: 100 Years of U.S. Consumer Spending

In 1901 yearly household income averaged $750. Annual expenditures for the average U.S. family averaged $769. Of this amount, 42.5% ($327) was allocated for food, 14.0% ($108) for clothing, and 23.3% ($179) for housing. The U.S. population was 76 million. There were 7.2 million owner-occupied housing units in the country, but only 19.0% of U.S. families owned a home, while 81.0% were renters. Grocery prices in 1901 averaged about 14 cents per pound for round steak or pork chops, 27 cents for a pound of butter, and 13 cents for 5 pounds of flour.

By 1919, average family income was $1,518 (a 102% increase), while household expenditures had increased to $1,434 (an 86% gain). The average U.S. household spent 75.4% more for food ($549), but the household's expenditure share for food had decreased to 38.2%. Spending for clothing had increased 120.4% to $238, but this category represented only 16.6% of total expenditures. Housing was where the significant change took place: spending for housing had increased 86.6%, to $334, although the expenditure share for this category remained 23.3%. The population in the country was 105 million. There were over 10 million owner occupied housing units in the country. Spending for housing had increased 86.6%, to $334, although the expenditure share for this category remained 23.3%. (The housing expenditure category included costs not only for rent, but also for fuel, light, furniture, and furnishing.) Families who lived in their own homes had a yearly rent (the term used in the Consumer Expenditure Survey) of $176. Families living in apartments or flats paid a yearly rent of $178. Retail prices had almost tripled since 1901. A pound of round steak cost an average of 37 cents, and pork chops averaged 39 cents. Five pounds of flour cost 34 cents, and consumers paid 58 cents for a pound of butter.

By 1936 - in the 15-year period following World War I, average family income had remained flat, rising only $6 to $1,524. Meanwhile, average family expenditures had risen 5.4% to $1,512. These dollars would have purchased $1,387 worth of goods and services in 1918 dollars, compared with the $1,434 that families in 1918 spent, demonstrating the deflationary effect of the Depression on the dollar's value. Food, clothing, and housing occupied a 76.2% share of household spending, a decrease from 1918-19. The expenditure share for housing was 32.0%, which translated into an average annual expenditure of $485. The number of owner-occupied housing units had increased to 14 million. Forty percent of families owned automobiles, almost all of which were purchased second hand rather than new. Average household expenditures for food were $508.

In 1950, the average family's income was $4,237 - an increase of 178.0% since 1934-36. Average family expenditures had increased 151.9%, to $3,808. This amount would have purchased $2,171 worth of goods and services in 1935 dollars, reflecting inflationary forces. Nationally, home ownership had increased, with 48% of all families owning their own home. Average annual housing costs were $1,035. Retail food prices had risen sharply from 1934-36 levels. The price of a pound of butter had doubled, from 32 cents to 73 cents. Meat prices also had risen sharply, with a pound of round steak increasing from 28 cents to 94 cents and pork chops from 26 cents to 75 cents per pound. Average household expenditures for food were $1,130.

By 1960, average family income in the country was $6,691, 57.9% higher than in 1950. Average family expenditures, $5,390, had increased 41.5% from 1950. This amount would have purchased $4,366 worth of goods and services in 1950 dollars. The U.S. population had surpassed 179 million, a gain of 19.0% from 1950. More than half of U.S. families were homeowners, with annual expenditures on housing being $1,588. Families spent proportionately less for food despite rising retail prices. One pound of round steak cost $1.06, up 12 cents from 1950. The price of a pound of pork chops had risen 11 cents to 86 cents per pound. More Americans (73%) owned automobiles, and they paid more for their cars. Average household expenditures for food were $1,311.

By 1972 the average family income was $11,419, an increase of 70.7% from 1960-61. The average U.S. household had an after-tax income of $9,731, having allocated 14.8% of income for taxes: $1,399 in Federal income taxes, $234 in State and local income taxes, and $55 in personal property and other personal taxes. The market value of the average household's financial assets was $7,094. Average household expenses were $8,348, an increase of 54.9% from 1960-61. This sum would have purchased $5,972 worth of goods and services in 1960-61 dollars. Average annual housing expenses were $2,551. Of total spending on housing, the average U.S. household allotted 51.4% ($1,311) for shelter (54.8% for owned dwellings versus 43.6% for rent), 16.0% ($409) for fuel and utilities, 17.4% ($443) for household operations, and 15.2% ($387) for furnishings and equipment. Most Americans [58.8%] owned their home (33.4% having a mortgage and 25.3% having no mortgage), while 36.8% were renters. The estimated market value of the average family home was $14,283, which translated into an estimated monthly rental value of $100. Some 80.1% of U.S. families owned at least one auto. These households spent $784 (9.5% of their expenditures) to buy and finance their autos. Additionally, they spent $750 (9.1%) on auto operating expenses. Average household expenditures for food were $1,596.

By 1984 average family income in the country had risen to $23,464, an increase of 105.5% since 1972-73. The average U.S. family had an after-tax income of $21,237, having allocated 9.5% of income for taxes: $1,733 in Federal income taxes, $431 in State and local income taxes, and $63 for other taxes. Average household expenditures, $21,975, had grown 165.7%. This amount would have purchased $8,790 worth of goods and services in 1972 dollars. Compared with 1972-73, the share for food had decreased to 15.0% ($3,290), while clothing had declined to 6.0% ($1,319), and housing had held steady at 30.4% ($6,674). Of total spending on housing, the average U.S. family allotted 52.3% ($3,489) for shelter; 24.5% ($1,638) for utilities, fuel, and public services; 4.7% ($315) for household operations; and 13.9% ($926) for household furnishings and equipment. Among U.S. families, 63% owned their own home (38% with a mortgage and 25% without a mortgage), while 38% were renters. The estimated market value of the average home was $47,269, and its estimated monthly rental value was $292. In 85% of households, there was at least one automobile, with an average yearly cost for transportation of $4,304. Average household expenditures for food were $3,290.

By 1996-1997 the average family income was $38,983, an increase of 66.1% since 1984-85. Average household expenditures, at $34,312, had grown 56.1% over the same period. This sum would have purchased $22,646 worth of goods and services in 1984 dollars. In terms of home ownership status, 64% of Americans owned their home (38% with a mortgage and 26% without a mortgage), while 36% of households were renters. Of total spending on housing, the average U.S. family allotted 56.4% ($6,205) for shelter, 21.6% ($2,380) for utilities and fuel, 13.0% ($1,432) for furnishings and equipment, and 4.2% ($459) for household supplies. The estimated market value of the average home was $74,835, which translated into an estimated monthly rental value of $521. Some 85% of U.S. families owned at least one vehicle, the average family owning 1.9. These families allotted 18.7% ($6,420) of their total spending for transportation, with 8.1% ($2,775) for the purchase of vehicles; 3.2% ($1,090) for gasoline and motor oil; and an additional 6.3% ($2,145) on other vehicle expenses, including financing and maintenance costs. Average household expenditures for food were $4,750.

By 2002-2003, the average family income was $50,302, an increase of 29.0% from the mid-1990s. Average household expenses, $40,748, had grown by 18.8% from the mid-1990s. This amount would have purchased $35,827 worth of goods and services in 1996 dollars. Of total spending on housing, the average U.S. family allotted 58.8% ($7,859) for shelter, 20.6% ($2,749) for fuels and utilities, 9.3% ($1,243) for household operations and supplies, and 11.2% for furnishings and equipment. Two-thirds of U.S. households (67%) owned their home (41% with a mortgage and 26% without a mortgage), while 33% rented. The estimated market value of the average home was $114,522, and its estimated monthly rental value was $735. Some 88% of U.S. families owned at least one motor vehicle, with the average family owning 2.0. These households allotted 19.1% ($7,770) of their total spending for transportation expenses, with 9.1% ($3,699) for the purchase of vehicles; 3.2% ($1,285) for gasoline and motor oil; and 5.9% ($2,400) for other vehicle expenses, including financing and maintenance costs. Average household expenditures for food were $5,357. The following spreadsheet summarizes the data on the growth of average family expenditures.

Average family expenditures - all items increase for period and per year
1934 1,512
1950 3,808 151.85%/16 = 9.491%/yr
1960 5,390 41.54%/10 = 4.154%/yr
1972 8,348 54.879%/12 = 4.573%/yr
1984 21,975 163.24%/12 = 13.60%/yr
1996 34,312 56.14%/12 = 4.687%/yr
2002 40,748 18.76%/4 = 4.689%/yr
Click to enlarge

So what does the last 100 years of data tell me about how much growth I need in my current portfolio? It tells me that if I am in my 60s or 70s, I want a plan for close to 5% income growth per year. Umpteen years of record federal budget deficits may not set off another round of 80s-like inflation. But I want a plan that is prepped for that event - just in case. I have supplied data on a 60s portfolio that meets that need. I also show the effect of a change in only one stock in that portfolio with a 60s Plan B portfolio.

As I approach my mid-70s, I can move to more secure investments as I build up the fixed income component of my portfolio. That move will also lower portfolio growth towards a 3% pace. But I do need to start that process slowly. A 75-year-old could live to 90. I will still need growth. But I also want to slowly lower my due diligence load over time. And that will be accomplished by moving out of equities.
I am way too young to start thinking about investment life in my mid-80s. I suspect that if I can get through my 60s to my mid-80s without touching capital, then I will have a plan that has done the best that it can do. An 85-year-old can still live to 100. I will still need some growth. On the other hand, I will probably want to maximize out my income while generating growth that falls slightly behind inflation. Let's now flash-back to our temporary presumptions: (1) "There are no bad stocks, there are only bad portfolios." And (2) "Retirement investing starts with knowing you portfolios' dividend growth CAGR." I will use my current CAGR data along with current yields to build three different portfolios. One will be for my 60s. One for my mid-70s. One for my mid-80s. I will show each portfolio in two different formats - with the first one shown in three formats. I want to show the math so that you can have a higher level of confidence in the data. And I want to show the effect of the different choices over a 20-year time period.

A 60s example - five years


Current Dividend Current 5 year LTM Div
Company Price /Quarter Yield CAGR Growth shares Invested Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5
REITs
O 41.72 0.181 5.22 3.00% 19.64% 240 10000 522 538 554 570 588 605
OHI 31.41 0.490 6.24 4.00% 11.36% 318 10001 624 649 675 702 730 759
MLPs
EPD 66.84 0.700 4.19 6.00% 7.69% 150 9999 419 444 471 499 529 561
MMP 68.75 0.585 3.40 8.50% 20.62% 146 10003 340 369 401 435 472 512
MWE 72.53 0.860 4.74 7.50% 6.17% 138 10002 474 510 548 589 634 681
Consumer Staples
CL 62.68 0.340 2.17 7.50% 9.68% 160 9997 217 233 251 269 290 311
GIS 49.89 0.380 3.05 7.00% 15.15% 200 9998 305 326 349 373 399 427
SJM 91.81 0.580 2.53 7.50% 11.54% 109 9998 253 272 292 314 337 363
BDCs
ARCC 18.41 0.380 8.26 1.00% 0.00% 543 10000 826 834 842 851 859 868
HTGY 26.00 0.438 6.73 0.00% 0.00% 385 10000 673 673 673 673 673 673

Total Income 99999 4653 4848 5055 5276 5510 5760

Yield on original dollars 4.65 4.85 5.06 5.28 5.51 5.76

Year over year Growth 4.19 4.28 4.36 4.45 4.53
The average yield is 4.65 and the average CAGR is 5.20.

Click to enlarge

A 60s example - ten years


Company Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10
REITs
O 522 538 554 570 588 605 623 642 661 681 702
OHI 624 649 675 702 730 759 790 821 854 888 924
MLPs
EPD 419 444 471 499 529 561 594 630 668 708 750
MMP 340 369 401 435 472 512 555 603 654 709 770
MWE 474 510 548 589 634 681 732 787 846 909 978
Consumer Staples
CL 217 233 251 269 290 311 335 360 387 416 447
GIS 305 326 349 373 399 427 457 489 523 560 599
SJM 253 272 292 314 337 363 390 419 451 484 521
BDCs
ARCC 826 834 842 851 859 868 876 885 894 903 912
HTGY 673 673 673 673 673 673 673 673 673 673 673

Total Income 4653 4848 5055 5276 5510 5760 6026 6309 6611 6932 7275

Yield on original 4.65 4.85 5.06 5.28 5.51 5.76 6.03 6.31 6.61 6.93 7.28

Year over year Growth 4.19 4.28 4.36 4.45 4.53 4.62 4.70 4.78 4.86 4.94

The average yield is 4.65 and the average CAGR is 5.20.

Click to enlarge

A 60s example - 20 years


Current Dividend Current LTM Div
Company /Quarter Yield CAGR Growth shares Invested Yr 0 Yr 5 Yr 10 Yr 15 Yr 20
REITs
O 41.72 0.181 5.22 3.00% 19.64% 240 10000 522 605 702 813 943
OHI 31.41 0.490 6.24 4.00% 11.36% 318 10001 624 759 924 1124 1367
MLPs
EPD 66.84 0.700 4.19 6.00% 7.69% 150 9999 419 561 750 1004 1343
MMP 68.75 0.585 3.40 8.50% 20.62% 146 10003 340 512 770 1158 1740
MWE 72.53 0.860 4.74 7.50% 6.17% 138 10002 474 681 978 1404 2015
Consumer Staples
CL 62.68 0.340 2.17 7.50% 9.68% 160 9997 217 311 447 642 921
GIS 49.89 0.380 3.05 7.00% 15.15% 200 9998 305 427 599 840 1179
SJM 91.81 0.580 2.53 7.50% 11.54% 109 9998 253 363 521 748 1073
BDCs
ARCC 18.41 0.380 8.26 1.00% 0.00% 543 10000 826 868 912 959 1007
HTGY 26.00 0.438 6.73 0.00% 0.00% 385 10000 673 673 673 673 673

Total Income 99999 4653 5760 7275 9364 12263
Click to enlarge

Why portfolio CAGR cannot be eye-balled

I want to take a minute to show one point - one's portfolio average CAGR can be something very different than what one would expect. That is because the average is not the sum of your weighted investments. To derive a portfolio average CAGR - you have to weigh the income flows from those investments. It is hard to put this difference into words. It is easy to express with numbers. Here are the numbers:


Portfolio with equal dollars put into two different CAGR investments


Current Dividend Current LTM Div
Company /Quarter Yield CAGR Growth shares Invested Yr 1 Yr 2 Yr 3 Yr 4 Yr 5
SJM 91.81 0.580 2.53 7.50% 11.54% 109 9998 253 272 292 314 337
ARCC 18.41 0.380 8.26 1.00% 0.00% 543 10000 826 834 842 851 859

Total Income 19998 1078 1106 1134 1165 1197

Yield on original dollars 5.39 5.53 5.67 5.82 5.98

Year over year Growth 2.52 2.60 2.67 2.75

The average yield and weighted average yield is 5.39 and the average CAGR - but not the weighted average CAGR - is 4.25.

Click to enlarge

Portfolio with equal incomes coming from two different CAGR investments


Current Dividend Current LTM Div
Company /Quarter Yield CAGR Growth shares Invested Yr 1 Yr 2 Yr 3 Yr 4 Yr 5
SJM 91.81 0.580 2.53 7.50% 11.54% 356 32684 826 888 954 1026 1103
ARCC 18.41 0.380 8.26 1.00% 0.00% 543 10000 826 834 842 851 859

Total Income 42685 1652 1722 1797 1877 1962

Yield on original dollars 3.87 4.03 4.21 4.40 4.60

Year over year Growth 4.25 4.35 4.45 4.55

The average yield - but not the weighted average yield - is 5.39 and the average and weighted average CAGR is 4.25.

Click to enlarge

The average CAGR of a portfolio with two different CAGR investments is the sum of the CAGRs divided by two "only" when the incomes from those two investments are equal (as in example two, where the incomes from both equal 826 in year one) - and not when the investments in those two differing CAGR components are equal (as in example one, where the investment in both is close to 10,000). For 99.8% of us, the computation of an average CAGR is one that we cannot sense with the naked eye. Until you do the math, you do not know where your portfolio income growth is headed. The math is a pain to do. It is a pain worth enduring. If you are a decent investor, your income flow from your portfolio will go where your plan takes you. I have done this for a number of years. I have no certainty what my portfolio's value will be three year from now. But I have a lot of certainty what the income flow from that portfolio will be three years from now.

I live off of what my portfolio allows me to spend. Having that certainty of a planned amount of income growth provides me with a significant amount of comfort. Back two years ago, when gas prices were growing a few cents per gallon each day for weeks at a time - causing the price of everything else go up - I stood at the gas station with a small but uncomfortable amount of exasperation as I pumped the gas into my car. Then a pleasant thought hit me from out of the blue. I remembered that "I have prepped for this." My portfolio was constructed for inflation events like this. The exasperation significantly dissipated. It was not a "Moses parting the Red Sea" kind of event - but it was a moment of satisfaction that I still remember. And it is an experience that you can have too.

If you are investing in income-producing equities because you want more control of your destiny - then you need to know where your current portfolio is taking you. Do the math. There is a real danger that you will be unhappy with that answer. If that is the case, then you need to be aware of that fact in the here and now. Even if half of your portfolio is in high-CAGR investments - you could still have a low portfolio CAGR. If you are the average investor that has been guided by the talking heads on Wall Street - the chances are strong that less than half of your portfolio is in high-CAGR stocks. Before I move on to the mid-70s portfolio, I wanted to show the effect of a relatively small change. In the following example, I will change the portfolio components by only one member. The examples only use ten components - so a one member change is a 10% change. But still, that is a relatively small change. For this example, I will only show a modified ten-year spreadsheet.

A 60s example Plan B - ten years


Current LTM Div
Company Yield CAGR Growth Invested Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10
REITs
O 5.22 3.00% 19.64% 10000 522 538 554 570 588 605 623 642 661 681 702
OHI 6.11 4.00% 9.09% 10001 611 636 661 688 715 744 774 804 837 870 905
MLPs
EPD 4.13 6.00% 6.15% 9999 413 438 464 492 521 553 586 621 658 698 739
MMP 3.24 8.50% 14.95% 10003 324 352 382 414 450 488 529 574 623 676 734
VNR 8.29 3.50% 3.75% 10000 829 858 888 919 951 984 1019 1055 1092 1130 1169
Consumer Staples
CL 2.17 8.00% 9.68% 9997 217 234 253 273 295 319 344 372 402 434 468
GIS 3.05 7.50% 15.15% 9998 305 327 352 378 407 437 470 505 543 584 628
SJM 2.53 8.00% 11.54% 9998 253 273 295 318 344 371 401 433 468 505 545
BDCs
ARCC 8.26 1.00% 0.00% 10000 826 834 842 851 859 868 876 885 894 903 912
HTGY 6.73 0.00% 0.00% 10000 673 673 673 673 673 673 673 673 673 673 673

Total Income 99997 4973 5163 5364 5577 5803 6042 6296 6565 6850 7153 7476

Yield on original dollars 4.97 5.16 5.36 5.58 5.80 6.04 6.30 6.56 6.85 7.15 7.48

Year over year Growth 3.82 3.90 3.97 4.05 4.12 4.20 4.27 4.35 4.43 4.50

The average yield is 4.97 and the average CAGR is 4.95.

Click to enlarge

A 60s example Plan B - 20 years


Current Dividend Current LTM Div
Company /Quarter Yield CAGR Growth shares Invested Yr 0 Yr 5 Yr 10 Yr 15 Yr 20
REITs
O 41.72 0.181 5.22 3.00% 19.64% 240 10000 522 605 702 813 943
OHI 31.41 0.480 6.11 4.00% 9.09% 318 10001 611 744 905 1101 1339
MLPs
EPD 66.84 0.690 4.13 6.00% 6.15% 150 9999 413 553 739 990 1324
MMP 68.75 0.557 3.24 8.50% 14.95% 146 10003 324 488 734 1103 1659
VNR 30.04 0.623 8.29 3.50% 3.75% 333 10000 829 984 1169 1389 1649
Consumer Staples
CL 62.68 0.340 2.17 8.00% 9.68% 160 9997 217 319 468 688 1011
GIS 49.89 0.380 3.05 7.50% 15.15% 200 9998 305 437 628 901 1294
SJM 91.81 0.580 2.53 8.00% 11.54% 109 9998 253 371 545 801 1178
BDCs
ARCC 18.41 0.380 8.26 1.00% 0.00% 543 10000 826 868 912 959 1007
HTGY 26.00 0.438 6.73 0.00% 0.00% 385 10000 673 673 673 673 673

Total Income 99997 4973 6042 7476 9418 12078
Click to enlarge

I switched high CAGR and lower-yielding MWE for lower CAGR and higher-yielding VNR. But VNR still is a decent CAGR. Given the size of your portfolio, this shift could have a meaningful change in your current income. After ten years, the first portfolio is growing at 4.95% while the "plan B" is growing at 4.48% per year. That is a 10% difference in growth. But the lower growth plan still has sufficient growth. Plan B starts out with (5105/4730) 7.928% more income per year.

When I compare stock to stock, I really like MWE better than VNR. But when I compare portfolio to portfolio, I can see why some people would prefer the second plan. For the duration of this article, I will argue that "there are no bad stocks, there are only bad portfolios." Both examples are good portfolios for a 60-year-old investor.

Why would I take the time to show a change that is not that much of a change? As future examples will show, bad things start to happen to portfolio income growth once your high-yield investments start becoming zero-CAGR investments. In this example, I changed to a higher-yielding investment that still had a decent CAGR.

Let's move on to the mid-70s portfolio. There are only two changes from the first portfolio - and one change from the Plan B portfolio. But that one change one again has an effect of both yield and growth. The first portfolio had growth of 4.19% and a yield of 4.65%. The second portfolio had growth of 3.82% and a yield of 4.97%. This third portfolio has growth of 3.28% and a yield of 5.43%.

A mid-70s example - ten years


Current LTM Div
Company Yield CAGR Growth Invested Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10
REITs
O 5.22 3.00% 19.64% 10000 522 538 554 570 588 605 623 642 661 681 702
OHI 6.11 4.00% 9.09% 10001 611 636 661 688 715 744 774 804 837 870 905
MLPs
EPD 4.13 6.00% 6.15% 9999 413 438 464 492 521 553 586 621 658 698 739
EEP 7.85 2.00% 0.00% 10002 785 801 817 833 850 867 884 902 920 938 957
VNR 8.29 3.50% 3.75% 10000 829 858 888 919 951 984 1019 1055 1092 1130 1169
Consumer Staples
CL 2.17 8.00% 9.68% 10004 217 234 253 273 295 319 344 372 402 434 469
GIS 3.05 7.50% 15.15% 9998 305 327 352 378 407 437 470 505 543 584 628
SJM 2.53 8.00% 11.54% 9998 253 273 295 318 344 371 401 433 468 505 545
BDCs
ARCC 8.26 1.00% 0.00% 10000 826 834 842 851 859 868 876 885 894 903 912
HTGY 6.73 0.00% 0.00% 10000 673 673 673 673 673 673 673 673 673 673 673

Total Income 100002 5433 5612 5799 5996 6203 6421 6651 6893 7147 7416 7699

Yield on original dollars 5.43 5.61 5.80 6.00 6.20 6.42 6.65 6.89 7.15 7.42 7.70

Year over year Growth 3.28 3.34 3.40 3.46 3.51 3.57 3.64 3.70 3.76 3.82

The average yield is 5.43 and the average CAGR is 4.30.

Click to enlarge

A mid-70s example - 20 years


Current Dividend Current LTM Div
Company /Quarter Yield CAGR Growth shares Invested Yr 0 Yr 5 Yr 10 Yr 15 Yr 20
REITs
O 41.72 0.181 5.22 3.00% 19.64% 240 10000 522 605 702 813 943
OHI 31.41 0.480 6.11 4.00% 9.09% 318 10001 611 744 905 1101 1339
MLPs
EPD 66.84 0.690 4.13 6.00% 6.15% 150 9999 413 553 739 990 1324
EEP 27.69 0.543 7.85 2.00% 0.00% 361 10002 785 867 957 1057 1167
VNR 30.04 0.623 8.29 3.50% 3.75% 333 10000 829 984 1169 1389 1649
Consumer Staples
CL 62.68 0.340 2.17 8.00% 9.68% 160 10004 217 319 469 689 1012
GIS 49.89 0.380 3.05 7.50% 15.15% 200 9998 305 437 628 901 1294
SJM 91.81 0.580 2.53 8.00% 11.54% 109 9998 253 371 545 801 1178
BDCs
ARCC 18.41 0.380 8.26 1.00% 0.00% 543 10000 826 868 912 959 1007
HTGY 26.00 0.438 6.73 0.00% 0.00% 385 10000 673 673 673 673 673

Total Income 100002 5433 6421 7699 9372 11587
Click to enlarge

Let's move on to the mid-80s portfolio. There are five changes from the first (60s) portfolio - and three changes from the 70s portfolio. Those changes had the effect of raising yield and lowering growth. The first portfolio had growth of 4.19% and a yield of 4.65%. The second portfolio had growth of 3.82% and a yield of 4.97%. The third portfolio had growth of 3.28% and a yield of 5.43%. This forth portfolio has growth of 1.82% and a yield of 6.47%.

There is only a 30% change in this portfolio from the last one. The three higher growth Consumer Staples stocks are dropped - and three preferred share stocks are added from major banks. Preferred share investments are zero-CAGR investments. The calculations I show ignore the effect of buying preferred shares below par. But you never know the actual call date on these investments - so a before the fact CAGR calculation would only be a guess. And there will be environments where one cannot find a good preferred selling below par.

Let me briefly describe those five investments that did not change.

Realty Income Corporation is one of a minority of REITs that did not cut its distribution during the credit crisis. It is a triple-net lease REIT, an attribute that adds some security to its income flows while lowering some of the growth potential. One can find REIT options with higher "yield + CAGRs" - but that comes with a sacrifice of adding more risk to that choice.

Omega Healthcare Investors (NYSE:OHI) is a healthcare REIT that invests heavily in Skilled Nursing facilities. Skilled Nursing is not one of the high valuation segments within healthcare. When it comes to FFO projection accuracy, Omega had some bad years back in 2008 through 2010. But there have been no disappointment since 2010 - and its dividend growth (along with FFO and FAD growth) has been great.

Enterprise Products Partners not only continued its distribution during the credit crisis - it continued raising its distribution during the credit crisis. It is one of the two top MLPs in terms of market capitalization. And Enterprise has the best rating on its debt of any MLP with a BBB+ from S&P. Just like Reality Income, you can find MLP options with higher "yield + CAGRs" - but that comes with a sacrifice of adding more risk to that choice.

Ares Capital Corporation is the largest BDCs, and one of the oldest. Its debt has a credit rating of BBB from Standard and Poor. Ares Capital cut its dividend (to 35 from 50) 30% during the credit crisis. But that 30% cut is less of a cut than most of its fellow BDCs in existence since 2005. Ares Capital's price has fallen approximately 7% since the beginning of 2007 - but up 180% since the beginning of 2009. Ares Capital is right at sector average for BDCs when it comes to its "yield + CAGR" - a valuation attribute that makes it, in my opinion, undervalued. There is no way that a safe portfolio would have a 10% weighting in BDCs. But due to going with very safe options in other parts of the portfolio, I believed I had a license to take some risk in one component. If you understand debt metrics and can watch parts of your portfolio like a hawk, then BDC investing is right for you with a very small portion of your portfolio. I do watch my BDCs like a hawk. BDCs are just under 5% of my portfolio.

HTGY is a baby bond for BDC Hercules Technology Growth Capital (NASDAQ:HTGC). It is the lone zero-CAGR investment in all portfolios. I believe I have read that no one has ever lost money investing in BDC debt. I do not remember the source of that information. HTGY has a 7% yield at par, and a duration that ends in mid-2019. It is hard to find a near 7% yield on debt with that short of a maturity. HTGC's baby bonds are both rated BBB+ by Kroll.

I could have pumped up the yields and income growth attributes by filling my sample portfolios with options that contain more risk. With the exception of ARCC, I have been on the conservative side in the selection of the components. In my personal portfolio, I do have some investments in those riskier options. Those investments strongly tend to have lower weightings. Also, I believe that I have set five-year CAGR projections that are conservative and realistic. All of the 20-year spreadsheet show the LTM or Last Twelve Month dividend growth. In all but one example, my CAGR projection is less than LTM dividend growth. That one exception is ARCC - and ARCC has had growth in "special" or one-time dividends. I ignore special dividends in almost all of my data.

A mid-80s example - ten years


Current LTM Div
Company Yield CAGR Growth Invested Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10
REITs
O 5.22 3.00% 19.64% 10000 522 538 554 570 588 605 623 642 661 681 702
OHI 6.11 4.00% 9.09% 10001 611 636 661 688 715 744 774 804 837 870 905
MLPs
EPD 4.13 6.00% 6.15% 9999 413 438 464 492 521 553 586 621 658 698 739
EEP 7.85 2.00% 0.00% 10002 785 801 817 833 850 867 884 902 920 938 957
VNR 8.29 3.50% 3.75% 10000 829 858 888 919 951 984 1019 1055 1092 1130 1169
Bank Preferred
JPM-D 6.40 0.00% 0.00% 9999 640 640 640 640 640 640 640 640 640 640 640
USB-O 5.93 0.00% 0.00% 10000 593 593 593 593 593 593 593 593 593 593 593
WFC-O 5.76 0.00% 0.00% 9999 576 576 576 576 576 576 576 576 576 576 576
BDCs
ARCC 8.26 1.00% 0.00% 10000 826 834 842 851 859 868 876 885 894 903 912
HTGY 6.73 0.00% 0.00% 10000 673 673 673 673 673 673 673 673 673 673 673

Total Income 100001 6469 6587 6709 6836 6967 7104 7245 7392 7544 7703 7867

Yield on original dollars 6.47 6.59 6.71 6.84 6.97 7.10 7.25 7.39 7.54 7.70 7.87

Year over year Growth 1.82 1.86 1.89 1.92 1.96 1.99 2.03 2.06 2.10 2.13

The average yield is 6.47 and the average CAGR is 1.95.

Click to enlarge

A mid-80s example - 20 years


Current Dividend Current LTM Div
Company /Quarter Yield CAGR Growth shares Invested Yr 0 Yr 5 Yr 10 Yr 15 Yr 20
REITs
O 41.48 0.181 5.25 3.00% 19.64% 241 10001 525 609 706 818 948
OHI 31.20 0.480 6.15 4.00% 9.09% 321 10000 615 749 911 1108 1348
MLPs
EPD 67.03 0.690 4.12 6.00% 6.15% 149 10001 412 551 737 987 1321
EEP 27.87 0.543 7.80 2.00% 0.00% 359 10000 780 861 951 1050 1159
VNR 29.99 0.623 8.30 3.50% 3.75% 333 9999 830 986 1171 1391 1652
Bank Preferreds
JPM-D 21.50 0.345 6.42 0.00% 0.00% 465 10000 642 642 642 642 642
USB-O 21.44 0.323 6.02 0.00% 0.00% 466 10000 602 602 602 602 602
WFC-O 22.15 0.320 5.78 0.00% 0.00% 452 10001 578 578 578 578 578
BDCs
ARCC 18.41 0.380 8.26 1.00% 0.00% 543 10000 826 868 912 959 1007
HTGY 25.90 0.438 6.76 0.00% 0.00% 386 10000 676 676 676 676 676

Total Income 100000 6485 7121 7885 8810 9933
Click to enlarge

A short summary

(1) There is a big difference in the yields and the dividend growth between the first example and the last example. At the same time, 50% of the investments were exactly the same. I hope that fact would emphasize the point that "there are no bad stocks, there are only bad portfolios." Put in different words, you can have a portfolio full of good investments and still have a portfolio that is not age appropriate. Even the point that "there are bad portfolios" is not 100% accurate. The last portfolio is a good fit for someone in their mid-80s (and is not living past 100). At the same time, it would be a terrible choice for someone just starting out in retirement. It is my concern - and my perception from the feedback I receive from fellow investors - that there are a lot of 65-year-old investors with portfolios that "fit" 85-year-old investors.

(2) I believe the multitude of examples provided in this article also brought home the point that until you have done the math, you do not really know your portfolio CAGR. Your naked eye will deceive you when it comes to grasping your actual portfolio's dividend growth. Half of the last portfolio was invested in stocks that had at least a 3% CAGR. Only 40% of the investments were zero-CAGR investments. But even with a majority of investments in growth-producing stocks, the portfolio CAGR was 1.82%. A portfolio with that small of an amount of growth is losing to inflation in every single year of its existence. Live with that kind of portfolio for more than five years, and will need to start "living on capital." At this point in time, I don't mind the idea of having to sell a small amount of shares to supplement my income flow once I become 90.

A short conclusion

Once upon a time, I had an attractive, 20-something female employee who would annoy me with a rhythmic childish chant of "you don't know what you're do-ing" when she witnessed me struggling with a task that I had not faced before. That memory echoes in my mind when I face difficult tasks in the here and now. We all have to face challenges that are outside our areas of expertise. When it comes to work - we muddle through. And when it comes to personal investing, when given opportunity - we procrastinate. We are all in unique stages of not knowing what we are doing. I am in a happy stage. I can celebrate the "knowing what I know" - as well as anticipate the future where the "knowing what I do not know" has a smaller and smaller inventory.

Without knowing what you own or of what you are in need, every investment writer should only be offering context sensitive suggestions. They don't usually do that. In your own purple haze of not knowing what you are doing, many of you are seeking and finding advice that does not fit you. It is my hope that this article emphasized that fact. It is the reader's obligation to know their own context and their own needs.

This is how I perceive we should think and act: We do not own trees - we own a forest. We do not own stocks - we own a portfolio. I want to end by placing emphasis on that one idea. We should not randomly invent our portfolio one stock at a time. We should not pump up our portfolio yield without knowing what that is doing to our portfolio's income growth. We start by knowing where we are already headed. To do that, we need to know our portfolio CAGR. Once we know that, then we can make the needed adjustments. We can add the stocks with the attributes that we need. Even when we arrive at retirement, we are still time traveling. With some hope, we are traveling with a portfolio that is designed to meet our future needs, while at the same time satisfies most of our current wants. That can be a difficult objective.

It is my hope that this article will haunt you with that chant of "you don't know what you're do-ing" until you know your portfolio CAGR. I wish I could offset that haunt with a pic of the employee that once haunted me. But I doubt that Seeking Alpha would allow that kind of thing (grin).

An even shorter PS

I am going to post a reader poll in the comment section of this page. I hope I can count on the participation of many of you. First - I will poll to see how many of you have already taken the extra effort to know their portfolio CAGR - how many do not - and how many plan to spend capital in retirement, so the question does not really apply to them. Second - I have provided sample portfolios that sum to $100,000. I will poll to see if there is a need (from some of the math impaired readers - and that could be a very large minority) for examples of the same portfolios that sum to $250,000 or $750,000. If there are more than 40 "likes" to those two questions, then I will create those "ten-year" spreadsheets and post them to my Seeking Alpha InstaBlog. These spreadsheets take time to create - but if you vote, they will come. Please do not post a written reply to the poll questions. You should reply to the poll questions with a click on the "like" button.

Disclosure: I am long ARCC, CL, EPD, GIS, MMP, MWE, O, OHI, SJM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I also have an investment in the baby bond mentioned in this article - HTGY.