Replace The 4% Retirement Rule With These 4% Dividend Stocks

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Includes: CVX, MO, T
by: Bob Ciura

Summary

The 4% Retirement Rule is frequently cited as a financial planning guide for retirees. But I believe the theory is flawed.

To me, investing in high-yield dividend stocks seems to be a better solution. There are many stocks yielding more than 4% that even raise their dividends over time.

And while the 4% Retirement Rule calls for a nest egg to eventually go to zero, retirees will not have to drain their savings by investing in dividend stocks.

As a result, investors could use dividend stocks as an even better retirement income strategy.

One of the more popular retirement financial planning strategies is the "4% Rule". This calls for retirees to withdraw 4% of their nest eggs each year, which would theoretically last through a 30-year retirement period. The 4% Rule gives retirees a look into how much they can expect to receive each year from their savings, and how long it will last before they run out of money.

When I first heard about this method, I soon found myself asking: Why do retirees have to run out of money at all? I wouldn't want to drain my retirement savings down to zero. As an investor, I think a better way to go is to make your money work for you. In exchange for a modest amount of risk, a person could easily construct an investment portfolio that is diversified and provides 4% (or greater) in investment income.

Go For Return On Capital, Not Return Of Capital

To me, the biggest advantage of investing for 4% yields instead of the 4% Rule is that it allows you to earn a return on your investment, not a return of your investment. Under the 4% Rule, you eventually run out of money. This in itself is a risk that should be considered, which the 4% Rule doesn't address. What if the person lives longer than 30 years?

By investing, a person can earn a return on their money. That will allow them to earn income from their investment, and at the end of a 30-year period, the portfolio value will remain. Many will opt for the 4% Rule, or a similar method, because of the fear of investing. After all, stocks and bonds can, and often do, lose value over a given period. But over long periods of time, stocks will rise in value. And I believe reasonably priced stocks with high dividend yields like Altria Group (NYSE:MO), AT&T (NYSE:T), and Chevron (NYSE:CVX) will reward investors over a 30-year period far in excess of what a withdrawal strategy would accomplish.

These companies are all large, established leaders in their respective industries. I chose them because they have strong brands and long histories of paying dividends and raising those dividends over time. There are many other companies from different industries that are equally strong dividend stocks. But I believe these three are a good starting point. Altria Group holds the Marlboro brand, and has increased its dividend 48 times in the last 46 years. AT&T is a telecommunications behemoth, and has increased its dividend for 31 years in a row. Last, but not least, Chevron is an oil & gas giant that has raised its dividend for 27 consecutive years. Assuming equal weights, an investor would earn a 4.5% combined yield from these three stocks.

The reason why Altria, AT&T, and Chevron have maintained such impressive dividend histories is because their profits have risen over time. All three companies have paid dividends without interruption for a very long time because their businesses have stood the test of time. I believe these companies, which have gotten stronger over the past many decades, will get even stronger in the decades to come.

Modify The 4% Rule: Include Dividends

The fear of falling stock prices is misguided. Stocks often go down in price, but those losses are on paper only. Investors who have the patience to ride out the short-term bumps in the road are rewarded over the long term. High-quality companies with strong brands and rising profits are very good investment options, even for a retiree. Retirees shouldn't be scared of the stock market. While it's true that stocks sometimes go down, over 30 years, I'd bet a portfolio of high-yield dividend stocks like Altria, AT&T, Chevron, and others will be worth far more than zero - which is exactly where the 4% Rule takes you.

The three stocks mentioned above are just a starting point. There are many other worthwhile stocks to consider. And there are other asset classes outside stocks to consider for income, like bonds. But the broader point is that retirees shouldn't have to drain their savings. When invested in high-quality stocks, retirees can easily earn 4% or more from dividends, with the added possibility of seeing their portfolios rise in value. Even better, investing in dividend stocks will generate income far above 4% once dividend growth is taken into consideration.

Disclosure: The author is long MO.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.