Usually when I read an article I'll either nod along approvingly or furrow my brow with a few questions. Opportunistically, here at SeekingAlpha.com we have the wonderful chance to comment on the articles as we see fit; better yet, the author will frequently respond directly to our remarks. But sometimes, albeit not as commonly, I will venture off the SA path to read articles on other financial websites. Most recently, this came in the form of Yahoo Finance's "Focus on Retirement" website. The article in focus was aptly titled: "The Worst Retirement Investing Mistake" and can be found here. Perhaps you noticed my clever title change. And while it would be possible for me to simply leave a comment and be on my way; for some reason I felt that my observations would fall on deaf ears. Thus I bring the debate to the more receptive (and hopefully appreciative) Seeking Alpha audience.
Essentially the article details the standard ho-hum advice that young investors have time on their side and thus they can take on more risk, whilst older investors are pitted against the clock and should avoid riskier assets. On the surface it sounds reasonable enough. In fact to the general public this is likely to be one of the main tenets of their financial wherewithal. To no one's surprise the customary "4% withdraw rule" would not be far behind. In fact, if we are speaking directly about non-dividend paying stocks and a short-term time horizon then the article in question makes perfect sense. But I have another idea, and I had a feeling it might take longer to express than a single paragraph on Yahoo.
The common argument to 'not caring' about market prices is DGI, or dividend growth investing. If you read enough articles on Seeking Alpha then surely you've heard the ins and outs of this strategy. Basically DGI is investing in a collection of high quality, wide economic moat companies that have not only the ability but also the storied track record of increasing their dividend payouts by a rate that far outpaces inflation over a lengthy period of time, usually decades. Whew, got all to fit in one sentence! Practically, this means investing in companies like Coca-Cola (NYSE:KO), Johnson & Johnson (NYSE:JNJ), Procter & Gamble (NYSE:PG), PepsiCo (NYSE:PEP) and McDonald's (NYSE:MCD). All of these companies have increased their dividends for a minimum of three and a half decades; meaning that if you invested in one or all of these companies anytime in the last 36 years you would have received more income every single year that you owned them.
The belief is that these wonderful companies will remain wonderful, such that they will continue to increase dividend payouts moving forward. Thus the typical DGI "cares" about market fluctuations in the form of being able to partner with a greater stream income. However, as the argument goes, once the dividend machine is built and throwing over ever growing streams of income, the DGI doesn't really care what other people may or may not be willing to pay for your partnerships.
Let's apply this concept to the standard advice doled out in the "Worst Retirement Investment Mistake" article. It should be made clear that the following arguments are not exclusive to these authors or even this article; the young = risky stocks, old = safe mantra is rather typical within financial recommendations. All of these quotes are directly from the linked article above.
"When you've won the game, why keep playing it?"
This refers to people that had enough money to retire before the financial crisis, but lost a significant sum in paper value by holding stocks in 2009. Isn't hindsight great? There are two points that I would like to make here. First, if you held a collection of dividend growth stocks "winning the game" is the equivalent to being able to cover all of your expenses with your solid stream of dividend income. And what happened to your income during the crisis? Well, let's see: Coca-Cola has raised their dividend for 50 straight years, the same goes for Johnson & Johnson, Procter & Gamble can boast about a 56 year streak, while PepsiCo's 40 year record competes with 'lowly" McDonald's and its 36 year mark. Assuming these companies do not have a time machine that means that your income actually increased during the worst financial crisis in recent memory. In fact, if you held an equal share in these 5 companies you would have seen your income rise by over 12% from 2008 to 2009.
The second point is that if you are relying solely on capital appreciation, especially in the short-term, then you are playing a different game than the dividend growth investor. Surely it's difficult to see your stocks value halved over a couple of months, regardless of what type of investor you are. But for the short-term investor holding a non-dividend paying stock, it's devastating; for the long-term DGI it's a perfect opportunity to buy more shares whilst your income keeps rising. If you walked into a Wal-Mart (NYSE:WMT) in early 2009, you probably would have seen something that looks inherently similar to today: people buying Cokes, Lay's potato chips and toothpaste.
"How risky stocks are to a given investor depends upon which part of the life cycle he or she is in"
Stocks don't know who's holding them. They are priced by an incredible array of varied investors. Sure, I will concede, that if you allow a toddler to drive a car then there's a greater chance of getting into an accident. But that's not the cars fault. And that doesn't mean that you don't let the toddler ride in the back seat; nor does it make the car any riskier. It's just a car. Likewise, it's just a stock. Yes, there is an inherent risk in owning either one of them. Nevertheless it is up to the owner to ensure that the risk taken is substantiated by his or her investing goals and not by a 'life cycle' definition. The true risk with dividend growth stocks is if one of your holdings cuts or freezes their dividend. But even then, this likely wouldn't be devastating.
"So if you have a long series of bad returns, plus you're withdrawing 4% or 5% of your portfolio to live on it, then in 10 to 12 years, you may not have anything left. Withdrawals during the distribution phase combined with a bad bear market can completely destroy a retirement."
I agree. Withdrawing 4% or 5% of your portfolio each year during a bear market would likely destroy a whole bunch of capital appreciation. For that matter, withdrawing 4% or 5% of your portfolio during any market doesn't exactly sound like a winning strategy to building a fortune. With dividend growth investing, the idea is to create a portfolio that can cover your expenses. It takes time, effort and patience but is well worth it in the end.
In year one of retirement you receive X amount of dollars. In year two, you receive X * 1.06 or whatever the growth rate might happen to be, likely outpacing inflation. If you reach a level whereby you can live off of your dividend income, then you're good. There's no need to worry about stock prices or having to sell any of your profitable business partnerships. It's the '0% rule'. Or perhaps for the ever so frugal, the "-4%" rule if you happen to reinvest some of the extra dividends you receive.
"You need to start bailing out of risky assets as you get closer to achieving that liability-matching portfolio"
Are they kidding? That's the whole reason that you're investing in the first place. I would liken this ideology to taking a road trip down to Florida in a car. Then when you're 50 miles away from your destination you decide to get out of the car and walk the rest of the way; suggesting that you "don't want to take too much risk for this last part". Sure it might be great if you had $5 million in cash and didn't have to mess around with all this investing mumbo jumbo. But if you need to make $50,000 in income to achieve your dividend retirement goals and you're currently making $42,000; please tell me how a "safer" but likely lower interest rate is going to get you there. Granted this example is easy to see in our current low-interest environment, but really the power of dividend growth and compounding allows it to hold in almost any scenario.
"It sounds like retirement success depends on when you were born. Yeah, that is certainly true"
I know I just used the 'are they kidding' phrase, but are they kidding? Tell me, who among us would ever buy into that. "Oh I was born in 1989 or 1975 there's no chance I will ever retire, woe is me". It's ludicrous. You have the ability to accomplish your retirement goals it simply takes time and effort. Sometimes the effort bit might be more difficult, sometimes it could come easily, but the opportunity is there for anyone to go out and achieve. Sure, the math works out that an indexed strategy, limited funds and time horizon might hinder your retirement planning. But you aren't forced to hold a collection of companies you know nothing about or don't really like, for reasons that are unknown to you. You have the ability to invest and spend as you choose.
"I've flown airplanes, and as a doctor, I've taken care of kids who can't walk. Investing for retirement is probably harder than either of those first two activities, yet we expect people to be able to do it on their own."
There are a multitude of difficult decisions and complex models that go along with finance. But investing is not astrophysics; as Warren Buffett says: "investing is not a game where the guy with the 160 IQ beats the person with the 130 IQ". It takes a certain amount of intelligence, sure, but not an uncommon amount. From there, temperance and logic will likely take you further than any spreadsheet or forecast ever could.
It should be noted that there are a variety of things that I agree with in the article. For example: the conversation discusses "human capital" as being one's greatest asset, he advocates the use of low expense index funds if one is so inclined to use such products and he makes the fundamental case that net buyers should hope for a market downturn in the short-term. However, regurgitating the same old "4% withdraw rule" and "stocks are risky when you're old" verbiage without knowing one's personal situation struck a nerve with me. If you haven't done so already, perhaps you give the cited article a once over and tell me what you think. Maybe I've been too harsh. Open forum.