The Real 'Better Advice For Seniors'

Includes: KO, MCD, PG
by: Five Plus Investor

An article was published by SA contributor Steven Bauer on June 29th which proposed in its title that the author had "better advice" for seniors. The article stirred up quite a hornet's nest, both on the subject matter and in regards to the author's motivation for publishing the article. His last article with Seeking Alpha was July 3rd, four days after the article in question was published.

Regardless of whether or not you believe the allegations leveled against him in the comment section, the author laid out a premise that stirred up a lively discussion and which bears further exploration. The author's proposal was:

There is a "better" way to invest with dividend stocks for senior retirees, and that is not to hold dividend stocks, but to trade them based on market or stock direction.

This premise begs some very important questions before any senior retiree attempts to follow through with any of author's trading suggestions. These questions will be addressed in two installments:

Part One - Can and should seniors who are retired and living off dividend income try to implement market timing and trading strategies to maximize growth and income?

Part Two - Should a retiree ever sell his dividend stocks? If so: when, why and how should this be done?

Answer to Part One: Probably Not

To answer the question, "should seniors implement trading strategies on their dividend portfolios," we need to look at two major tenets of investing: phases and strategy.

  • Tenet #1 -Phases of Investing: Accumulation vs. Distribution
  • Tenet #2 - Strategy: Income vs. Growth Investing

Unfortunately, Steven Bauer mish-mashed all of these tenets together to create one massive ball of confusion. He failed to understand that some strategies that are safer in accumulation are not so safe in distribution; and there are strategies that work with growth stocks that don't work so well with dividend stocks.

So I will state from the outset: my conclusion is that senior retirees are better off not attempting to "trade the market" with their dividend stocks.

This doesn't mean I advocate that they never sell or adjust holdings to increase income. It simply means they should not attempt, at this phase of their lives, to be a growth strategist, if they have never in their investing lives been one, and have always invested for income.

If I were to modify the author's premise to my own recommendation, it would be:

Trading dividend stocks with market timing is not a "better" way to invest for senior retirees. The point of a dividend portfolio is to hold dividend stocks for retirement income. Do not trade based on market or stock direction, but on fundamental issues and the ability to increase income.

To understand why I would modify the author's recommendation, we need to delve briefly into the two tenets I mentioned. I will then address two major sources of confusion when we mess with and mish-mash these tenets.

Tenet #1 - Accumulation vs. Distribution

For whatever reason, the notion that there might not always be one way to invest all your life seems to be a foreign concept for many investors. We invest for retirement, seemingly unaware that - yes, one day we will retire.

There is accumulation - then there is distribution. These are highly divergent stages of an investor's life.

Accumulation Phase:

  • Investor is working and earning income
  • Primarily buys investments, rather than sells
  • Investor seeks, but has not yet achieved a target goal (accumulated assets or income)
  • Seeks to maximize investments
  • Is usually younger
  • Normally has higher risk tolerance

Distribution Phase:

  • Investor may, or may not, be working
  • Normally takes place when investor is ready to retire
  • Primarily disposes of investments (or spends dividends)
  • Investor has likely achieved target investment goal
  • Emphasis is on protecting, rather than maximizing, investment
  • Is normally older
  • Has low risk tolerance

Accumulation puts in; distribution takes out. It's pretty much as simple as that, yet it is this difference that is at the heart of why risky trades cannot possibly be recommended for those in the distribution phase.

Tenet #2 - Growth vs. Income Strategy

It is also apparent to anyone perusing the Income Investing section that two philosophies of investing are seemingly at war with one another. These are:

Growth Strategy - achieved with capital gains
Income Strategy - achieved with income growth

For the purposes of Steven Bauer's article, the author used "dividend growth" stocks as his proposed trading vehicle. Right off the bat, we have a problem. Dividend stocks are not growth stocks.

I won't belabor the two strategies, but anyone interested in understanding the many flavors of income investing should read the opening statements of my first article.

Source of Confusion #1 - Too Much Mixing of Strategies

This is the crux and heart of my dispute with the article, and whether or not the article provided "good advice": It confused what is advisable in strategy for the different phases of an investor's life.

Here is the problem:

  • You can mix investment strategies easier in the Accumulation Phase
  • You can't mix investment strategies so easily in the Distribution Phase

Attempting to "trade the market" - maximizing capital based on market ebbs and flows - is flat-out a growth strategy, not an income strategy. However, I'm going to ruffle the feathers of my dividend growth friends with my next statement. That is:

Implementing a growth strategy within a dividend growth portfolio is not a bad idea - in the Accumulation Phase.

The accumulation phase assumes a younger age; the ability to work and continue to earn; and the ability to make up any losses assumed by a trading strategy.

However, when we get to the Distribution Phase, it's a very different story. It's at this juncture that the real purpose and implementation of our chosen strategy manifests itself:

  • Growth Strategy: If you have implemented a growth strategy in the accumulation phase, your retirement income comes primarily from the harvesting of capital gains in the distribution phase. Implementing this strategy successfully involves, in no small part, selling at the best possible price points and using market timing for maximum income.
  • Income: If you have implemented a dividend strategy in the accumulation phase, your retirement income comes primarily from the harvesting of dividends in the distribution phase. Implementing this successfully involves, in no small part, to the holding of dividend-generating stocks and the protection of the dividend stream.

In the distribution phase, the growth strategist seeks to sell in retirement, and the income strategist seeks not to sell in order to live off dividend income in retirement. This is a very different paradigm to the accumulation phase, in which the investor does not use or need dividend income to pay for living expenses.

How is it then advisable for a senior retiree who has built up a substantial portfolio of dividend stocks - accumulated over 30, 40 even 50 years - to suddenly switch strategy gears and become a growth investor? Aren't these investors using the dividends from the long-held portfolios to pay the bills?

Trading and redeploying to increase income is one thing; trading on the whims of the market is a growth strategy that the lifelong income investor who is living off his dividends literally cannot afford.

Source of Confusion #2 - You Can't Plow a Field with a Toyota…

Income stocks such as PG, KO and MCD are not growth stocks. Growth stocks such as AAPL and GOOG are not income stocks. They act differently, and serve two different purposes.

It's just common sense. You would never attempt to plow a field with a Toyota Camry, and you surely wouldn't try to drive a tractor plow 70 mph on a highway. Vehicles need to be used for the purpose they are intended in order to be effective.

Stocks aren't that much different. Simply put…growth stocks certainly make lousy dividend stocks, and dividend stocks don't always provide the monumental growth needed to make a growth strategy work for retirement.

Why try to drive a dividend stock into the mold of a growth stock, when that's not the real purpose for the retiree? Even if you are attempting to reap some capital gains on your dividend stocks during the accumulation phase, at the distribution phase, you need to use that tractor to plow the field it's intended for.

Here is the "Better Advice"…

Bottom line: If you are a senior, retired, in distribution phase and invested in dividend growth stocks, you need the income the "holding" will provide you more than the capital gains the "selling" will net you.

You need the income because you understand and respect the phase of life you are in. In retirement, the point is less about accumulating, more about reaping the rewards of your accumulation.

You also need to respect the strategy and vehicle you have chosen for retirement income. It's not wise to treat your dividend stock like a growth stock by trading for capital gains. Instead, treat a dividend stock like a dividend stock, and enjoy the dividends.

Should you need to sell your dividend stock, the trading decision should not be based on the stock's trading value or market direction. Instead, selling decisions should be made on stock and company fundamentals. If the fundamentals are signaling significant long-term decline, by all means sell. But you are not selling a growth stock; your gains will not match that of a growth stock held for 30 years. Instead, look for ways to redeploy funds into new investments which will increase your income.

That, my friends, is "better advice" for seniors.

Disclosure: I am long MCD. 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.