A Less Risky Way To Quit Working In 5 Years With $330,000

by: Michael Foster Financial Services


It is possible to build a high income portfolio that covers savings if one is frugal, a high income earner and a savvy investor.

While CEFs and BDCs offer one approach to this goal, dividend growth stocks offer a similar income stream in just 5 years.

I show how an upper middle class income earner can use dividend growth stocks to get enough income in 5 years to cover her expenses.

I recently wrote an article about how a hypothetical 25 year-old upper middle class American could retire in 5 years after saving $330,000. To call it controversial would be an understatement; many comments focused on disbelief that any worker earning six-figures could survive on $2,000 per month. I consider this a non-issue; the average median household income was $53,657 in 2014 (data has not been updated since); assuming a two-income household, that's a bit over $26,000 per person:

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Of course, many Americans earn far less and are still surviving. So can Jane, my hypothetical 25-year-old earning $70,000 post-tax.

A less common but, I think, more reasonable criticism of my approach is the high-risk income-producing portfolio that I recommended to Jane for her post-work life. That portfolio included Main Street Capital (NYSE:MAIN), AGIC Equity and Convertible Fund (NYSE:NIE), PIMCO Dynamic Income Fund (NYSE:PDI), and Pimco Dynamic Credit and Mortgage Income Fund (NYSE:PCI).

With two levered CEFs that rely on junk bonds, this portfolio might be a bit too risky for some. And while I consider NIE to be a great fund (I have written a couple times about its strength, and I'm not alone in liking it), it doesn't provide growing dividends and its reliance on convertibles may be overly risky for some.

Meanwhile, Main Street Capital is a concern for some because of its massive premium to NAV (versus peer BDCs, most of which are trading at a discount) and its reliance on loans to smaller companies that may be more prone to failure. Again, I consider these non-issues but because they are risks for some, let's avoid that as well.

Without these stocks, and without similar stocks with similar risks, can Jane still quit her job in 5 years and have enough income to cover her expenses? Of course she can.

Investors might prefer a lower-risk approach by diversifying into a group of dividend growth stocks that have a track record of increasing dividends and strong EPS. With the exception of one stock, we can build a portfolio with positive EPS, sustainable dividends, and a history (albeit admittedly short in some cases) of dividend growth.

The portfolio includes 7 stocks: Apollo Global Management (NYSE:APO), Blackstone Group (NYSE:BX), Chesapeake Lodging Trust (NYSE:CHSP), Helmerich & Payne (NYSE:HP), Sotherly Hotels (NASDAQ:SOHO), Seagate Technology (NASDAQ:STX), and W.P. Carey (NYSE:WPC). With REITs, financials, energy, and technology, this is a diversified portfolio of profitable companies:

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Profitable, that is, with one exception: HP. With the fall in oil, HP has fallen into an EPS loss, but the company's long history of dividend hikes makes it a reasonable option for this portfolio:

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This is especially true considering its diversified operations and strong balance sheet (for more, see this article). Despite the current oil-driven downturn, HP is in.

Our other stocks are not dividend champions, largely because some are new. However, their 5-year dividend history shows promise:

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Note that APO and BX have had volatile distributions. Given the nature of these financial firms, this is to be expected; however, this is actually good for Jane. To take APO as an example: the dividend went from 20 cents 5 years ago to 37 cents today. That's an 85% increase in 5 years. But payouts between 2013 and 2015 were actually much higher, meaning that if Jane had started on this journey 5 years ago, she'd have received considerably more income than if we'd seen a steady dividend increase.

Let's not assume that will happen again; instead, let's expect volatile dividends between now and 5 years in the future. Let's also assume 2% annual capital gains that can be rebalanced into the portfolio annually while dividends are reinvested, giving us an 8.2% total return. This is not impossible, given the portfolio's past 5-year performance:

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Thanks to the companies' dividend growth, we end up with a portfolio that yields 8.3% of current prices in 5 years:

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Note the yield is even higher for a 10-year period.

Going back to Jane's savings table, we see again that her portfolio's return and this higher yield results in a passive income stream that exceeds her expenses, assuming 2% inflation:

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For those interested in quitting their job early and amassing a large income stream to cushion themselves for an indefinite period of time, these dividend growth stocks are an option. They are by no means the only one -- various other portfolios with similar returns are possible. I prefer CEFs and other high-yield instruments, but for those who do not, these stocks would work as well.

The moral of the story is clear: There are many paths to getting a high income stream in a relatively short period of time. Jane doesn't have to work the bulk of her life and save conservatively to get to a traditional, conventional retirement. Other options are available for those that want them.

Disclosure: I am/we are long PCI, PDI.

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.