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Summary

  • A portfolio of mega cap blue chip dividend payers are passive income producers for retirement.
  • Once an investor is retired, where will the money come from to pay expenses?
  • Growing income and reducing expenses are the keys to a secure financial future.

Several days ago I read this article by David Van Knapp about selling shares versus receiving dividends to support a financial lifestyle for each investor. I found it to be a very compelling article by this writer who has authored some very fine books on the subject of dividend growth investing. I would suggest that you take some time and read the article, and while you're at it, spend a few dollars on David's books.

The article has over 400 comments currently and will probably be a lightning rod for both value and growth investors for quite some time. The main thing that struck me was the wide divergence of opinions as to which road is better, and for the life of me, I cannot understand why it has become so difficult to understand that for dividend growth investors, the income received is the lifeblood of the strategy, and by selling shares, the passive income will be reduced.

In my own way, using the BTDP as a model, I will used my own dumbed down version of my opinion to attempt to explain our approach for a regular investor.

Passive Income From Investments Is Like Being A Silent Partner In A Business

Many folks who save for retirement have a desire to invest in some sort of business that will pay them regularly, so that they can have a more secure retirement. To me, investing in quality companies is like owning a sliver of many businesses that pay stakeholders a portion of its earnings back to shareholders in the form of dividends.

Take a look at a 2 month old BTDP as of our last update: The BTDP consists of the following stocks: AT&T (NYSE:T), Exxon Mobil (NYSE:XOM), Johnson & Johnson (NYSE:JNJ), Coca-Cola (NYSE:KO), Procter & Gamble (NYSE:PG), Altria (NYSE:MO), McDonald's (NYSE:MCD), Chevron (NYSE:CVX), Apple (NASDAQ:AAPL) General Electric (GE), Ford (NYSE:F), Microsoft (NASDAQ:MSFT), Wal-Mart (NYSE:WMT), and Pfizer (NYSE:PFE).

Owning a sliver of each of these great companies will offer an investor an opportunity to derive income simply by holding a small stake in each of these companies.

As of the last update, the annual income from a 109k beginning investment will generate an income from the "passive business ownership" of roughly $3,800.

Here is the breakdown:

SymbolSharesOrig.YieldDividendYrly IncomeShare PriceTot.CostTot. Value30-AprDiv/Cash
T3005.60%1.8455231.95958510710$35.70
XOM1002.80%2.7627690.05900510196$101.9669
JNJ1003.10%2.828086.78867810129$101.2970
KO2003.00%1.2224437.2174428158$40.79
PG1003.10%2.4124175.7175718255$82.55
GE3003.60%0.8826424.3573058067$26.89
MCD1003.50%3.2432493.02930210138$101.38
CVX1003.60%4400111.141111412552$125.52
AAPL152.25%13.16197526.4578978851$590.0949
MO1005.20%1.9219237.7137714011$40.11
F4003.20%0.520015.1560606460$16.15
MSFT2002.80%1.1222440.1680328080$40.4056
WMT1002.50%1.9219276.1176117971$79.71
PFE2003.20%1.0420832.1864366256$31.2852
xx3.60%x3794x109809120,130x$296

That might not sound like a lot of money but at a current yield of nearly 3.80%, an investor can rely on these companies to help create cash flow, just as a silent partner would hope to receive from an investment in an actual business. Of course that business will not have the diversification that investing in a broad assortment of various stocks in various sectors has, but the goal is the same; income from owning a piece of a business.

At the same time, the investors who plunks down a chunk of money in a business venture will also gain an equity stake, not unlike that of the investor who owns shares of stocks in a variety of companies. As a matter of fact, there will more than likely be much more liquidity in stock investing than in business ownership.

The money that both investors glean from their investment will hopefully help the investor reach their goal; more income, greater net worth, for a more secure financial future.

A Retired Investor Still Needs To Pay The Bills

An individual retires with an income of $50k and expenses of $40k (both annually after taxes) hypothetically. Now that the regular paycheck has stopped, and the retiree has only a pension (big maybe these days) of $10k per year and Social Security of about $20k per year, the gap between income and expenses will immediately be around $10k based on my hypothetical numbers.

If the retiree has saved $500k over a span of a 30-40 year career, they can decide to simply duplicate the portfolio about with roughly $400k in the same allocation, and multiply the income received from dividends based on the just the BTDP by a factor of about 4x.

That would mean an income right off the bat of about $16k per year from dividends before taxes, to close the gap between income and expenses.

The retiree who decides to invest or buy a business for passive income such as that could do the same thing if the business is sound and solid, but like stock ownership, nothing is guaranteed. In reality, stock ownership in mega cap dividend champion or dividend winning stocks is much less risky in my opinion, plus the fact that the majority of the companies in the BTDP have track records of giving raises (dividend increases) to its stakeholders just about every single year for over 60 years in a row in some cases.

The average "raise" is roughly 4-5% on the lower side and 6-10% on the higher side, depending upon the company policy for dividend increases, payout ratios, cash reserves, and earnings growth. The stocks in the BTDP have an above average rating in this area. With most of the stocks, there is little question as to whether or not an investor will get an annual "raise". That fact cannot be duplicated just by investing directly in a single business...more than likely, it will be a crap-shoot, but also an opportunity if the business becomes very successful.

Both investors have the same goal; pay expenses with the income derived from their investments. Since there are truly only two ways to achieve this goal it is worth a very brief overview:

  • Reduce expenses below income received.
  • Increase income above expenses owed.

Not rocket science for sure.

Growth Stock Investors Feel That Selling Shares Of Stock Is The Same As Receiving A Dividend

This is where the difference of opinion lies. I will simply give you my opinion and you can decide which path you want to take.

If a business owner is not making any money from his investment (no income) that investor can choose to place his equity stake up for sale, either in bits and pieces, or all at once. If the business has grown, the equity stake will be worth more than the initial cost...that will be wonderful, but once the equity stake is gone, it's gone, and then another strategy needs to be employed to achieve the goal of a more secure financial future.

For the investor who invests in stocks that might not pay dividends, shares can be sold on a regular basis for that investor to have money to pay expenses. If the shares have increased in value the investor has made a profit. Any profit is a good profit in my book and I sell shares all the time but for different reasons. The end result is that the investor will have less shares of a particular stock and the current value will be reduced by the amount sold.

That investor would now need to either reinvest in another stock or alter their strategy to achieve the desired goal, paying expenses and having a more secure financial future. Since there will be less of a total portfolio value by selling shares, then if the share price retreats, then perhaps the amount sold next time will be less, unless of course additional shares are sold to make up the difference.

Whatever the case, this is called depletion of assets and for many investors it is the path they feel is right for them.

Receiving a dividend from an investment is not depletion of assets. When a dividend is paid, and taken as cash (not reinvested) the number of shares remains the same, and no matter what the share price becomes, the amount of income will either be the same or more in the months ahead based on the stocks within the BTDP.

In my opinion, this is where the two strategies part ways. As far as I am concerned, I would prefer to know that I do not need to sell any percentage of my ownership stake to keep my cash flow coming in. The benefits are so clear to me that I tend to get confused as to why a different type of investor fails to acknowledge the beauty and simplicity of this approach.

Taking it just one step further, if the dividends are reinvested into the same stocks as held in the BTDP, over time, that investor will have more of a stake in the businesses invested in, and more than likely a greater amount of money coming in, or greater cash flow - without selling one single share.

The investor who attempts to duplicate this fact by selling shares is depleting assets that they own, not growing them. Unless of course the market continues to rise and the stock picker is very accurate.

To state emphatically that selling shares of stock is the same as receiving dividends is completely and utterly false. It might be a desired way for an investor to reach their goal, but it is by no means, that I can fathom, the same, or as sound, as receiving dividends with regular increases year in and year out.

I am not a math whiz, that's for sure, but I do not believe I need to be. Dividend income has been, and probably will continue to be, the most successful form of creating passive income for the individual investor who seeks a more secure financial future, or retirement, in just about any market scenario.

The Bottom Line

I sell shares I take profits and I redeploy the cash into other dividend stock opportunities to grow my income. I also rebalance every quarter or so, to keep my allocations reasonable. I am not against selling shares of stock to create more wealth or income.

That being said, I cannot find another strategy that will duplicate my efforts that easily, if at all, and just by selling stock to duplicate dividend income is not a sound strategy in my book.

Disclaimer: The opinions of the author are not recommendations to either buy or sell any security. Please remember to do your own research prior to making any investment decision.

Source: Retirement Strategy: Dividends Are Passive Income Generators For Retirement