Current fixed income interest rates are so low that those seeking income for retirement have gone to extreme measures.
A dividend opportunity stock is fine for a risk allocation, not for a total portfolio.
Dividend growth investing has stability and flexibility. Chasing yield is unstable and can box you in.
I have had many requests to put a portfolio together of high yielding dividend stocks. Mainly in the mREIT, MLP, and BDC sectors. At first glance, this looks like a wonderful way to create a very high income stream right off the bat. Unfortunately, far too many folks who are retired, fall for the bait and come to learn that their entire budget can turn into a disaster, rather quickly.
A Sampling Of The Havoc That Chasing Yield Could Cause
I know very few folks, but there are some, who have built a portfolio of high yielding stocks, and have dodged every single bullet. As an example, let me put a small portfolio together to show what could happen.
The stocks I have chosen happen to be dividend opportunity stocks, which I happen to like as a risk allocation in a very well diversified portfolio of dividend growth stocks. Let's take a brief look at what a concentrated portfolio of high yielding dividend stocks could do to a retiree.
Let's Call This Portfolio "Chasing Yield Is Stupid" Or CYIS
This small portfolio consists of American Capital (NASDAQ:AGNC), Annaly Capital (NYSE:NLY), Linn Energy (NASDAQ:LINE), Prospect Capital (NASDAQ:PSEC), Hatteras Financial (NYSE:HTS) and Chimera Investment (NYSE:CIM). I will use these stocks because I have either owned them at one time, or currently hold at least one, for a dividend opportunity risk allocation position.
My hypothetical investor retired in 2009, just as the stock market was coming out of its hole. As you can see in the chart above, each of these stocks offered a very high dividend yield and payment back then, and fixed income products were beginning to pay nearly meaningless interest.
At the beginning of 2009, this investor plunks down a huge chunk of his retirement savings, into 1,000 shares of each of these dividend "dream" stocks, and feels he has successfully developed a large income stream, while his neighbors were scared as hell because of the low interest rate environment.
This investor sets up his budget to fit quite nicely with the income received from his smart investments; leases a nice new luxury car, goes on a few cruises on credit, does some home improvements using credit cards, and buys some nice clothes on credit as well. His annual expenses that are being paid for by this portfolio is roughly $16k per year, and the income from this portfolio, based on the 2009 dividend stream would cover him, and "probably" cover these expenses for the time required to pay these bills off. Let's say 10 years making regular payments, not missing a beat.
Here is what that chart would look like:
|Stock||Shares||2009 DIV||2013 DIV||09 VALUE||13 VALUE|
Thankfully, the new car lease is only for 4 years, so at least THAT payment has dropped most likely, replaced with a less expensive one, hopefully.
As you can see from the chart, 2009 was a very good year, and actually 2010 and 2011 were ok as well, but were dipping. This investor was boxed in however, because he needed the income, and didn't want to sell at a loss!
Lo and behold 2013 rolls around as you can see, the annual income has gone from roughly $17k, down to about $12k. The expenses stayed the same even with the minimum payments made to the credit cards. The 30% drop in income puts this investor's entire retirement plans and hopes in jeopardy, and if he wants to dump everything at the end of 2013, the value of the stocks held is also lower.
Where will this dividend growth chaser put his money to work after this fiasco? More than likely, not only will his standard of living decline precipitously, but he has bills to pay off and has less money to do it.
A recipe for disaster!
These are the folks you have seen driving fancy cars one day, and the next day they are selling their home, and moving in with their kids.
You don't think this can happen? Come down to South Florida and I will take you around to some of the very folks this has happened to.
Chasing yield is looking for, and finding, a disaster.
The Bottom Line
Obviously this is a hypothetical case, however I personally know many wealthier folks who followed this path in various forms, and have had to go back to work at age 75 just to buy food.
A dividend growth strategy with core holdings that actually pay you more every year, and have much more stability, combined with an appropriate expense budget, will enable you to have a more secure financial future, hopefully for a lifetime.
Think about it.
Disclosure: The author is long NLY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.