Only the richest of the rich can retire stress-free right? Wrong! The key is to have enough income to cover expenses. Once you start dipping into your investment principle, that is when the stress begins. Think of an hourglass turned over. That is the principle dwindling away.
But if there is enough income to cover expenses each year in retirement, you have effectively placed a stopper on that hourglass and the sand (your investment principle) is no longer slowly moving towards zero.
Generating Income Is Not As Easy As It Once Was
Are interest rates ever going to rise back to historical norms? Well, let's look at Japan.
Interest rates pretty much peaked in 1991 and have not even come close to that level since. The same thing can happen here. We might not see 5% treasury yields again for years if not decades.
Dividend-Growth Stocks To The Rescue
Some people have bought into the annuity craze as a substitute for bonds. Don't believe the hype. Most annuities are loaded with hidden fees and surrender charges, not to mention limited choices for investments.
Instead, I recommend dividend-growth stocks for income before and during retirement. I wrote about this recently here as well.
I believe in investing in dividend-growth companies that have shown they can increase their dividend again and again over time. A very good place to start is by looking at the Dividend Aristocrats.
Dividend Aristocrats are by definition high-quality businesses, since their dividends have gone up by 25+ years in a row.
A Case Study
We can talk about this strategy all we want. But I believe in placing numbers on a theory. So let's look at a case study example. I ran this analysis in our WealthTrace Planning Software, which is available to the public. The couple we will analyze is 55 years old today. They want to live on passive income in retirement and plan on doing this the old-fashioned way: by using Treasuries. My assumptions are below.
Notice in the chart below how their income does not cover their expenses in every year. This means they are dipping into their investment balances to cover the shortfall. The hourglass begins to drain.
Given that they are draining the investments, we projected that they will run out of money by age 88.
My solution is to move them into dividend-growth stocks with a long history of increasing (or at least never cutting) their dividends. My favorites are Exxon (NYSE:XOM), Altria (NYSE:MO), Johnson & Johnson (NYSE:JNJ), and Procter & Gamble (NYSE:PG).
5-Year Div. Growth Rate (Annualized)
Johnson & Johnson
Procter & Gamble
I am also most definitely not recommending that people invest in only a few dividend-growth stocks. Investors should diversify among many dividend-growth stocks that have characteristics similar to the companies I list above.
Now I want to move half of their money into dividend-growth stocks and out of treasuries. I assumed an average dividend yield of 3.5%, an average dividend growth rate of 7%, and average stock price growth of 3%.
Look at that: no shortfalls in any year. Income covers expenses, which means their investment principal is not touched. This is a great position to be in.
It is not as easy as it once was to generate income in retirement. But by seeking out solid dividend payers who have a long history of dividend growth, those approaching or in retirement can still keep their investment principal intact by making sure income always covers their expenses.
Disclosure: I am/we are long XOM,JNJ,PG, MO.
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.