How Dividend Growth Stocks Make Retirees Richer

by: Tim McAleenan Jr.

Most of the articles that focus on dividend growth investing discuss how dividend growth companies benefit investors as they seek to compound wealth and prepare for retirement or whatever their needs may be. Today I'm taking a look at the benefits of dividend growth stocks once investors reach their "magic number." Let's say that an investor amasses that $1 million or $2 million dollars worth of dividend growth stocks (or whatever the amount may be), and then decides that it's time to start living off the dividends to meet his lifestyle needs. What happens then?

I compiled a list of 25 companies often associated with dividend growth investing (some of them, like General Electric (NYSE:GE) and US Bancorp (NYSE:USB) are currently in the dividend doghouse due to the dividend cut during the financial crisis. Others, like Walt Disney (NYSE:DIS) and Clorox (NYSE:CLX), are on the dark horse side: Disney for paying out dividends annually, and Clorox for temporarily cancelling dividends altogether in 1986. Here is the long-term compounded dividend growth rate of each of these companies since 1992: (Click to enlarge)

The fun thing about this list is that if we could borrow a time machine and go back to 1992, the firms that dominated many areas of American business then are largely the same companies that are still at the top today. Hershey (NYSE:HSY) was the dominant candy maker in 1992. Coke (NYSE:KO) and Pepsi (NYSE:PEP) sold products on every store shelf then. Exxon (NYSE:XOM) was an oil king and annual member of the largest American companies list. AT&T (NYSE:T) had a dominant foothold in the telecommunications industry. Clorox and Colgate-Palmolive (NYSE:CL) were making the household cleaning products that were filling the shelves of the rapidly expanding and near-ubiquitous Wal-Mart (NYSE:WMT) stores. Boeing (NYSE:BA) was one of the largest defense firms in the country. And if you were going to smoke a cigarette or eat some Kraft (KFT) macaroni and cheese, there was a good chance it came from Altria (NYSE:MO). General Electric was one of the original members of the Dow Jones index in the late 1890s, and despite a dividend cut during the financial crisis, still managed to compound dividend growth by 6% since 1992.

So once you have put together your own list of dividend growth stocks of companies with strong brands, ever-growing profits, and storied histories of dividend growth, what happens next? You watch your dividend growth portfolio beat the pants off inflation and increase your purchasing power every year during retirement.

When dividend growth investors mention their desire to live off dividends, the focus is usually on how this strategy avoids the depletion of assets. But there is another very strong benefit to living off the income from dividend growth stocks: These stocks can actually increase your purchasing power over time during retirement.

Since the early 1990s, inflation has run about 2-3% annually. The income from every one of these companies- even US Bancorp which experienced a severe dividend growth cut during the financial crisis- managed to compound annual dividends at a rate greater than inflation (thus increasing purchasing power), and many of them managed to do so by a rate much greater than inflation.

If you managed to hold Becton Dickinson (NYSE:BDX), Johnson & Johnson (NYSE:JNJ), McDonalds (NYSE:MCD), Heinz (HNZ), Wal-Mart , or Altria during this time period, you were able to experience dividends compounding at a rate 3, 4, or 5x the prevailing inflation rate. Just owning one of these firms during the past twenty years could alone make an investing career successful. And it's not like Johnson & Johnson was this tiny small-cap in 1992 that went on to have an explosive twenty-year run. In 1992, Johnson & Johnson had a reputation for being an American healthcare behemoth just like it does today. If David Fish had been compiling CCC lists back in 1992, most of these companies would have displayed apparent Dividend Champion-like characteristics then, just like they do today.

This is one of the more underrated aspects of dividend growth investing-it has a killer end game. If I load up my portfolio with Coke, Pepsi, Procter & Gamble, Johnson & Johnson, and Colgate-Palmolive, I can be pretty sure that I'm going to experience 7-11% annual dividend growth over the coming years. Nothing in investing is guaranteed, but every dollar we invest forces us to make a prediction of some sorts, and betting on these firms to continue their records of annual dividend growth is a bet that I won't lose any sleep over making.

If inflation runs at 3-4% over the medium term, many dividend growth investors can probably construct a portfolio that of 7-8% annual dividend growth without breaking a sweat. At that point, you can watch your purchasing power increase at a rate twice that of inflation. In a world where many investors fear running out of money during retirement, a portfolio filled with dividend growth stocks can actually make you richer from the day you retire until that 100th birthday rolls around.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.