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Since 2007 we have been watching one financial crisis after another unfold. Greece has defaulted, Spain is moving that way, the euro is in danger of disintegrating, and the U.S. continues to add on $1.5 trillion deficits to its debt. Meanwhile, the Federal Reserve continues to hold short-term interest rates near 0%, which makes for a terrible situation for those wanting to invest in fixed-income. Times are more than interesting when it comes to investing; they're downright fraught with danger.

There has not been a tougher time to invest for retirement since the Great Depression. Planning for retirement these days is not as simple as it once was, if it ever was simple. Many people do not want to stick their money in bonds earning less than inflation, but they fear that investing in the stock market will only lead to another disaster for them if we have another year like 2008 or 2009. This kind of stress can keep a person up at night.

I believe that even in this tough investing climate there is still a mix of asset classes that will help investors generate a decent total return by keeping them in the stocks of safer dividend paying companies which are not too cyclical and have shown that they will not cut their dividends when the economy goes south.

Let me start out by saying that I do not believe in having any money in non-inflation indexed bonds today except for funds that are needed for liquidity reasons. I recently wrote about my opinions on fixed-income here. However, I do believe there is room for Treasury Inflation Protected Securities (TIPS) in retirement accounts. With the Consumer Price Index running near 3% year-over-year you are getting a total yield of about 1.5% on a five year TIPS bond. That is quite a bit higher than the regular five year treasury yield of .85%. But perhaps more importantly, TIPS give your retirement portfolio a nice hedge against future inflation. If you can put all of the TIPS in a tax-deferred retirement account, you will also avoid paying taxes on the inflation portion of the income generated.

The core of my suggested retirement portfolio for most people is based on investing in companies who have the following characteristics:

  1. They pay a dividend yield above 2.5%.
  2. They have shown that they will not cut their dividends, even in an economic downturn.
  3. They have shown a culture of raising dividends over time.
  4. Their earnings are not too cyclical.

Four companies who meet these criteria and form a good portion of my own retirement portfolio are Johnson & Johnson (NYSE:JNJ), Coca-Cola (NYSE:KO), Wal-Mart (NYSE:WMT), and Owens & Minor (NYSE:OMI).

Company Ticker

Div Yield

5 Year Div
Growth Rate

Paying Dividends Since

Last Time
Div Was Cut

JNJ

3.6%

9.1%

1970

Never

KO

2.8%

8.7%

1962

1969

WMT

2.7%

16.9%

1974

Never

OMI

3.1%

14.9%

2007

Never

Not only did these companies not cut their dividends during the terrible recession of 2008 and 2009, all four of them were able to increase their dividends during this time. They form the core of my retirement portfolio, and with good reason. I sleep well at night knowing that these companies can withstand tough economic times. Even if their stock prices decline with the rest of the stock market during another recession, I am confident they will at the very least maintain their dividends.

I ran some scenarios in our retirement planner looking at how a retirement portfolio might fare under tough economic conditions. I took a couple that is 45 years old and used the following assumptions: They have $400,000 in assets, half of which are in tax-deferred retirement accounts. They will receive a combined $30,000 per year in social security when they turn 67. They contribute $10,000 per year to their investments. They will retire when they are 62 years old. Inflation is assumed to be 3% per year and they will spend $40,000 per year in retirement. They are 90% in equities and 10% in 10 year treasury bonds. Lastly, I assume they will live until age 90.

The first scenario I wanted to look at was a long period of slow economic growth that lasts twenty years. I assumed under this scenario that a stock market index like the S&P 500 would only return 2% per year. I found the following results for this couple:

Investment Balance at Retirement

Age When Funds Run Out

Investment Value At Age 90

$532,000

80

$0

This couple is in serious trouble if equities only return 2% per year. They won't be retiring at age 62, that's for sure. But what if instead of investing in a typical stock fund that is cyclical and pays very little in the way of dividends, they invest in companies such as the four I have already mentioned. Let's assume that these companies are able to grow their dividends over time by half of their five year dividend growth rate and that their stock prices rise by 2% per year. Here is their situation now:

Investment Balance at Retirement

Age When Funds Run Out

Investment Value At Age 90

$760,000

Never

$337,000

Not only will they never run out of money, they will be able to leave $337,000 to their heirs. Looked at another way, they will have a buffer of $337,000 during their retirement to work with in case their expenses are higher than expected or their return assumptions were too rosy.

What if these companies can only increase their dividends by 25% of their growth rate today?

Investment Balance at Retirement

Age When Funds Run Out

Investment Value At Age 90

$725,000

Never

$215,000

Even with this conservative assumption, this couple never runs out of money in retirement. It is also important to point out that by the time this couple retires they are living off of the dividend income of the stocks they own. They care much less about the principal value of their holdings at this point since the dividend income is what will sustain them. Again, this can help any retiree sleep better at night knowing that they don't have to watch the day to day gyrations in the stock market.

The power of increasing dividends over time is too often underestimated. As I have shown, the ability to find companies that consistently grow their dividends over time can help set you up in retirement even if the economy stagnates for years to come.

Source: Retirement Portfolio For An Uncertain World