Seeking Alpha
Recommended for you:
Portfolio strategy, dividend investing, REITs, value
Profile| Send Message|
( followers)  

Summary

  • Dividend stocks possess discernible advantage in a retirement portfolio.
  • Dividend payments are assured, unlike stock price appreciation.
  • Some dividend stocks to consider.

In a recent article, an author advised that the best course for a wealthy retiree may be to avoid dividend paying stocks altogether and opt strictly for growth stocks. The argument seemed to center around the tax efficiency and inflation protection that a growth oriented portfolio would provide. In this quasi-rebuttal article, I'd like to argue why dividend stocks, and not growth stocks, should form the backbone of a retirement portfolio.

What's Rich Nowadays, Anyway?

When I read the title to the referenced article, I wasn't sure how much money defined rich. The subject turned out to have $15 million, which to me is filthy or outrageously rich. Of course $15 million could signal poverty comparatively speaking to your Mark Cubans, Carlos Slims and Bill Gateses of the world. On the other hand $100K could be rich to someone who's broke. So it's all a matter of perspective.

Regardless, the fact of the matter is that from an inflationary perspective, the "millionaire" designation, the common bellwether of wealth according to the American dollar, isn't what it used to be. However, depending on the type of yielding investments one utilizes, an income of $100,000, or more, (10% yield) off that million dollars could be generated on publicly traded securities. That might be plenty for one retiree, but not enough for another to live off of. But whether shooting for 10% on one's investments is prudent or not is a topic for another article.

My sense is that most reading this piece don't have $15 million, and never will. So I will appeal in general to those that are building towards personal retirement "riches" or are already there, with a desire to prudently build and capitalize off of what they have.

The "Problem" Of Growth Investing

The following is a recommended asset allocation blueprint set up by our "anti-dividend" author.

Asset class

Allocation (%)

Treasuries, short term

35

Cash

5

Stocks that don't pay dividends

60

As I mentioned previously, the author believes that from both a tax and inflationary perspective, a growth investing tilt is a wise course of action. In unqualified accounts, I would concur that the tax efficiency benefit of growth stocks is not something to be questioned. Whether growth stocks, on a total return basis, will beat your dividend payers over the long-term is certainly arguable, however.

The innate problem for the retired investor who relies too heavily on growth or value stocks that don't pay a dividend is this - what happens if we are on the cusp of a multi-decade bear market? While the assumption has always been that stocks will return a historical "8%," there have been extended periods of market history where stocks have flat-lined, a point I made in a recent article. If you are drawing on capital that you assume will grow - and it doesn't - either flat-lining, or worse yet, dropping in value through retirement, you could very well run out of money. Whether that was to happen or not would be contingent on your spending habits and beginning capital base. Why risk the chance?

The Dividend Stock Advantage

If you develop a cash flow strategy through variable use of dividend stocks, bonds, or other income investing tactics, you, to an extent, take away the unknown forward market variable of price. Thus, think of dividend investing as a hedge against market sell offs or secular bear markets or more generally, stock price volatility

While you may or may not grow capital as much as if you were invested in growth companies, you glean periodic dividend payments from established businesses that are in a position of strength to share their profits with equity holders. Whether the price of Coke (NYSE:KO) goes up, down, or sideways going forward, you can buy today with a 3.2% yield and get $32,000 a year in dividend payments off a million dollar investment.

And chances are, Coke's dividend payment will rise in excess of inflation on an annual basis. To an extent, one should view retirement investing as a game of calculated odds. Do I have better confidence in the fact that Coke will continue to pay and raise its dividend on an annual basis than I do in the fact that its stock price will rise on an annual basis? Thus, do I want to take what I know the company will give me now and probably in the future, rather than live on a hope and a prayer that Coke's or any other stock's price will rise?

If you are 30 and think you can pick home runs and stocks you think will rise hyperbolically in price, I say go for it. If you are 70 and don't necessarily need tremendous growth of capital to provide for your needs - then focus on dividends and dividend growth - it just makes sense.

The Major Disadvantage of Dividend Stocks

With total return of a given growth stock and a dividend stock being equal over time, the growth stock does provide for a tax edge in a non-qualified account. Every year income from a dividend stock will be taxed, while growth stock return is deferred until a sale. Further, if you own a lot of higher dividend payers that are not characterized as paying "qualified" income, you will be paying Uncle Sam at your nominal tax rate. However, there are some tax shielded options, like MLPs, that distribute what is known as return of capital, or ROC, a tax-deferred payment that reduces security cost basis.

So certainly the effect of taxation should be taken into account as you craft a portfolio, but the positive attributes of dividend paying stocks should also be taken into account. Unlike the asset allocation suggestion provided by the author disliking dividend stocks, I don't see allocation as necessarily an all or nothing thing. One can certainly own both dividend and non-paying dividend stocks in retirement, regardless of one's capital base.

Strategy Session

Asset allocation is a critical aspect of portfolio management. While you can go to various web sites and find rules of thumb and recommended blueprints on how much you should allocate to various asset classes, I wouldn't put much stock in that advice. Where one puts their money, especially in retirement, is a highly personal endeavor predicated more on what one is comfortable with as opposed to what a textbook says is right.

If one has $15 million and needs $200,000 on which to live (1.33% yield), that person can invest much differently than someone with $1.5 million and needs $100,000 to live on (6.66% yield). Initial allocation decisions thus, to an extent, need to be made by virtue of capital base and income need.

So our $15 million "whale" can probably look at a higher allocation to bonds, cash, and other capital preservation tactics, while also garnering inflation protection from growth and dividend growth stocks. Suggestions would include dividend stalwarts like Procter & Gamble (NYSE:PG), Johnson & Johnson (NYSE:JNJ), General Electric (NYSE:GE), and maybe a REIT like dependable Realty Income (NYSE:O). For the non-dividend growth section of a retiree portfolio I would certainly look to scale and diversity. A company like Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) would seem to fit the bill.

Our second investor will have to take a far different approach to achieve the income need, with a higher allocation to equities and riskier bonds. While aforementioned lower yielding dividend growth stocks may be utilized for inflation protection, higher yielding bonds and equities will also have to be considered to up blended yield. Double digit choices, option-income funds like ETV & EXG, as well as business development companies like a Prospect Capital (NASDAQ:PSEC) or Fifth Street (NASDAQ:FSC), could be utilized. REITs like O, American Realty (NASDAQ:ARCP), or Home Properties (NYSE:HME) may also fit into the allocation.

If high-yield bonds are to your taste, I currently like Alliance Bernstein Global (NYSE:AWF) and Prudential Global Short Duration (NYSE:GHY).

Summary

I feel dividend stocks, specifically dividend growth stocks, should be part, perhaps most, of a retired investor's portfolio that seeks inflation protection and reasonable total return over time. I simply do not think it makes sense to chiefly depend on stock price appreciation, when you can hedge your bets with companies that throw off cash to you on a monthly, quarterly, or semi-annual basis.

As I write this piece on March 13, 2014, the DJIA is down about 175 points. Are we at the onset of a secular bear market? Who knows. But if I were a retired investor I'd be much more comfortable sitting on a bunch of dividend payers, than non dividend payers, if we are.

Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.

Source: Rich And Retired? Please Buy Dividend Stocks