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Dividend growth investing, retirement
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Perhaps you are wondering whether the income from the portion of a retirement portfolio that you allocate to dividend-growth stocks will keep up with inflation. It’s an important question. Inflation is the hidden leak that all retirement plans must account for.

The news is good. While stock prices move up and down all the time, dividends almost always go up.

Whoa! Dividends only go up?? At first glance, that sounds like a ridiculous statement. Companies cut or freeze their dividends all the time. Didn’t a bunch of banks drop their dividends, or cut them to a penny, just a couple years ago? Didn’t BP eliminate their dividend shortly after their rig blew up last year?

Yes, they did. But in a well-selected portfolio of dividend-growth stocks, the total dividends paid by the portfolio almost always goes up. In any given year, the vast majority of stocks in the portfolio that raise their dividends more than makes up for the one or two clunkers that cut them. The total dividend stream rises each year.

The S&P 500 in no way represents "a well-selected portfolio of dividend-growth stocks." More than 100 of its companies don’t even pay dividends. But statistics from the index can be useful to illustrate broad trends. The following table compares the S&P 500’s total dividends paid by its stocks each year since 1988 to inflation.

S&P 500 ANNUAL DIVIDEND CHANGES VS. INFLATION

YEAR

DIVIDENDS IN BILLIONS $

CHANGE IN DIVIDENDS

%

ANNUAL INFLATION RATE

%

12/31/2010

$205.83

4.5

2.6

12/31/2009

$196.95

-20.3

-1.4

12/31/2008

$247.29

0.8

3.8

12/31/2007

$245.38

9.5

2.8

12/31/2006

$224.11

11.1

3.2

12/31/2005

$201.78

11.5

3.4

12/31/2004

$181.04

12.7

2.7

12/31/2003

$160.65

8.7

2.3

12/31/2002

$147.79

3.9

1.6

12/31/2001

$142.22

0.8

2.8

12/31/2000

$141.09

2.6

3.4

12/31/1999

$137.55

6.8

2.2

12/31/1998

$128.80

7.7

1.6

12/31/1997

$119.57

6.2

2.3

12/31/1996

$112.62

10.8

3.0

12/31/1995

$101.68

6.9

2.8

12/31/1994

$95.14

8.0

2.6

12/31/1993

$88.10

3.4

3.0

12/31/1992

$85.22

4.1

3.0

12/31/1991

$81.90

1.8

4.2

12/31/1990

$80.45

8.5

5.4

12/31/1989

$74.16

9.9

4.8

12/31/1988

$67.49

22 YEARS (1988 omitted)

$100

becomes $306.06

$100

becomes $184.16

(Sources: S&P 500 annual cash dividends from "Dividends" tab of S&P 500 Earnings and Estimates Report dated 3/15/2011. Annual inflation rates from Bureau of Labor Statistics, Consumer Price Index-All Urban Consumers-All Items. Annual dividend percentage changes and "$100 becomes" figures computed by the author.)

In the 22 years that calculation of dividend increases is possible from the data available on the S&P website—

  • The total dividends paid by the companies in the index declined only once, in 2009. The total went up in every other year. (By comparison, the value of the S&P 500 index itself—representing "price"—declined in 7 of the 22 years.)
  • Dividend increases exceeded inflation in 17 of the 22 years. In those years, if you were using the dividends as an income stream, you could have used the extra dollars either to increase your standard of living or to reinvest back into the portfolio to compound, thus further increasing future dividend streams.
  • The cost of $100 worth of goods at the end of 1988 rose to $184.16 in 2010. $100 worth of dividends in 1988 rose to $306.16 in 2010. So dividend growth outpaced inflation by a factor of 1.66.

No well-selected dividend portfolio's dividend stream has ever plunged 10-20-30 percent in a year that I know of. The stock market, on the other hand, does that periodically, most recently in 2008 (-38%).

Furthermore, and of great importance when you are talking about living off the dividends in retirement rather than selling assets to create income, when a stock’s price goes down, it means that you have lost value. But when a dividend is cut, that simply means that you receive less. If it is cut to zero, you receive nothing. But you don’t actually lose money. There is no such thing as a negative dividend.

The following table shows the annual dividend increases in my public Dividend Growth Portfolio compared to the annual dividend increases in the S&P 500’s stocks and inflation:

DIVIDEND GROWTH PORTFOLIO ANNUAL DIVIDEND INCREASES

YEAR

DIVIDEND GROWTH PORTFOLO

DIVIDEND INCREASE

FROM PRIOR YEAR

%

S&P 500

TOTAL DIVIDENDS PAID

INCREASE FROM PRIOR YEAR

%

ANNUAL INFLATION RATE

%

2010

15

5

2.6

2009

19

-20

-1.4

This portfolio has only been in existence since 2008, so annual increase figures are only available for two years. The small sample size proves nothing, and the fact that I reinvest dividends spins the comparison positively. But the numbers do support the general thesis that a portfolio of well-selected dividend-growth stocks will outperform the S&P 500 in metrics that are important to retirees: yield, annual growth, and dollars received.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.