How much will I need to retire? It's the age old question investors address throughout their working years, but more so as they approach and surpass mid-life. While it's never been an easy question to answer, it's becoming much harder. An uncertain outlook for Social Security, a low interest rate environment, and a rickety global economy are playing games with just about everyone's pre-retirement investment plans and income assumptions.
Meanwhile, unless our gridlocked motley crew of suits on Capitol Hill acts by the end of this year, investors will see their dividends and capital gains taxed at a higher rate starting next calendar year. Dividend taxes will rise substantially and be set at ordinary income rather than the current 0 or 15% rates, and long-term capital gains rates will see slight increases of no more than five percent. Being an investor, especially an income investor outside a qualified account, could become significantly less rewarding.
So, having said this, what type of strategy should a middle-aged investor employ with a ways to retirement? Go for the gusto with gains and growth, or look to established, dependable names that pay dividends but offer restrained capital growth potential? The answer is a very personal decision and comes down to a number of tangible and variable factors: confidence in one's stock picking ability, risk tolerance, current capital, future capital needs, estimated future market returns, and capital yield requirements, among other things. Most investors end up employing a mix of strategy, both growth and income, which is tweaked for the rest of their lives.
Where do you currently stand?
Some 'mid-lifers' with significant assets may be able to take a more conservative and passive route by establishing a portfolio of dividend paying stocks and/or other income vehicles and collecting or reinvesting dividend checks now, with less consideration for capital growth. In other words, barring a dramatic market meltdown, they're in a very comfortable position. Others may be pressed to make capital work harder and take on a more active role in their investments to get to a point where dividends and/or other income generators substitute for a paycheck.
Given a lackluster decade where equities underperformed historical benchmark returns, it may be uncomfortable for many to invest in anything off the beaten path or in stocks that possess a high risk/reward profile. However, for investors who feel like they are falling behind their long-term goals, a good defense, in this case, may not be the best offense.
Dividend Growth Revisited
The dividend growth crowd on SA is a knowledgeable, free-spirited bunch. I posted an article some time ago that provided a constructive critique of the strategy. While I stand by that article, additional interaction with DG adherents has helped me to continue to understand the variety of ways that investors can look at stock prices, depending on goals and life situation. Dividend growth is the core strategy for many investors and so it should be, because it is sound and conservative philosophy, defensive, if you may. However, in my view, DG should not be utilized as a core equity strategy by younger investors who feel they are behind capital growth goals.
While it may seem more constructive and perhaps comfortable to invest in dividend payers now and track a growing income stream, it may in fact, be more productive to focus on capital growth and defer the bulk of the income strategy until closer to retirement, especially if one is not currently dependent on investment income. If you focus on growing capital rather than income at an earlier age, I would argue you stand a good chance, all else equal, of ultimately being able to generate more income during retirement.
That's not to say that dividend stocks can't provide growth, they do, but not in general, the potential for well above average capital growth that someone behind the 8-ball needs.
Mining for Gems
Despite a stock market that has languished for the past decade, significant wealth creation potential always abounds. Investors who discover opportunities before others can make mountainous profit out of a molehill investment, albeit with variable increased risk. Despite a flat market the past decade, investors in Apple (AAPL), Priceline (PCLN), and countless others have made fortunes by being early and being patient. Over the past six weeks investors in Human Genome Sciences (HGSI), Barnes & Noble (BKS), and Vivus (VVUS) have doubled their money on a takeover bid, outside investment, and drug approval, respectively.
You don't have to wildly speculate to find growth opportunities. Expose yourself to small-cap, biotech, and emerging markets, and other high-growth areas, while at the same time keeping an eye out for oversold, quality stocks that have near-term, correctable problems, in other words seek out contrarian, value situations. And never be afraid to take profits and move on to better ideas if you consider a situation fully valued - there's never a bad time to take a profit. Stock "attachment" is one of the biggest stumbling blocks for investors managing their own portfolios. Never fall in love with a company, otherwise you'll end up married to it and won't know when to let go. There are other fish in the pond - catch and release.
While the proverbial mid-life crisis can cause stress in one's life, don't let it affect your investment judgment. Define your situation, find a strategy you are comfortable with that you estimate can achieve your goals, and invest accordingly. If time is on your side, let it work to your advantage.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.