Wednesday, January 15, 2014

My Dividend Goals for 2014 and after

With the end of 2013, many dividend investors are reviewing the year that passed, and are updating their 2014 goals. As I am reviewing results from my portfolio, I am trying to understand if I am on track to reach my goals.

The three inputs that will help me achieve my goals are organic dividends growth, reinvestment yield and new capital to invest. In my book, organic dividend growth is merely a result of corporations approving increases in distributions to shareholders. I strive for a 6% in annual dividend growth on average. Since I am in the accumulation phase of my dividend investing journey I am also reinvesting dividends into more income producing securities. I believe that if my portfolio keeps growing distributions by 6 – 7% per year, and I reinvest this cashflow back into more dividend paying stocks yielding 3- 4% today, I can essentially grow total dividend income by approximately 10% per year.

This of course assumes that I no longer put any new capital to work in dividend paying stocks. The biggest change I implemented in 2013 was to reduce the amount of contributions to my taxable accounts to the minimum. This was because I am starting to max out tax-deferred accounts such as 401 (k), Sep IRA and Roth IRA, in order to cut down on taxes today, and create a vehicle where I would generate dividend income that won’t be taxed for at least 30 – 40 years. When you put money in taxable accounts, you can withdraw dividends from one account and easily pool them into another account. Unfortunately, with tax-deferred accounts, the money generated in one account has to stay there. I am doing this, because my largest expense in my budget is taxes. This includes Federal, State and FICA taxes.

My taxable accounts would likely generate a sufficient stream of income to reach my dividend crossover point within five years. This would be as a result of organic dividend growth, dividend reinvestment and fresh additions of investable funds. I do believe that I need to be generating more in dividends than what my regular monthly expenses are, just to be on the safe side. Because I would be earning more than what my typical monthly expenses would be, I would be paying taxes on the buffer income I won't be using. Therefore, I have added the assets that would generate this dividend income buffer in tax-deferred accounts. I would have to jump through hoops in order to access these funds, which is why I would only tap them in the case of extreme circumstances. There is a high likelihood that these funds would not need to be used ever, but could provide a potential buffer in case I am wrong in my calculations. Plus, the money would compound tax-free for decades, before the tax person gets their share, if I do not need to use them.

Now that I provided some high-level background on the status of accounts, I am going to go over my goals for the next few years. As I had mentioned before, I plan on becoming FI by 2018. After looking at the numbers, it looks as if I am on track to reach this goal. I am currently able to cover approximately 60%-65% of expenses with dividend income. This is a slight improvement from 50% – 60% that I was able to cover in early 2013. Using a conservative 10% growth in total dividend income, I come up with the following calculations:


Year
Expenses Covered by Dividends
2013
60%
2014
66%
2015
73%
2016
80%
2017
88%
2018
97%

The table shows percentage of monthly expenses that are covered by dividend income at year end. I have simply compounded the percentage of expenses covered by dividends by 10%/annum. It looks like I am on track right now to accomplish my goals. I prefer to discuss goals in terms of the longer-term goal, rather simply focus on isolated annual goals. I think that for 2014 I would strive for approximately 70% in dividend income coverage, but this is meaningless without understanding how this goal fits in the grand scheme of things.

The percentages in the table do not include dividends generated in tax-deferred accounts. I expect that most of my future contributions will be in tax-deferred accounts, which would hold the excess dividend income, that would be part of my safety net. Some portions of income will make their way to taxable accounts, which might increase the percentage of expenses covered by dividends. However, in order to be conservative in my assumptions, I am not going to change these estimates in the table above.

I am also not putting down exact dollar figures, because reasonable expenditures vary from individual to individual. For example, for a single individual living in the Midwest that owns their residence, they can probably get by on say $1,500/month. However, if you are a married couple that lives in New York City or San Francisco, you would likely need at least $4,000 - $5,000/month merely to get by. The goal of this article is not to debate whether a certain dollar figure is reasonable or not, but to discuss my thought process in getting to a reasonable goal within a reasonable time. After all, these are my numbers, and they make sense for me - your numbers are going to be much different.

Therefore, in order to get to a place, you need to determine what your goal is. Write it down, and then try to determine how to get to that goal. I figured out early that I would achieve my goal with my diversified portfolio of dividend growth stocks, which are companies that regularly boost distributions for shareholders. I then determined the monthly amount I plan to invest each month, and also determined reasonable assumptions about returns. Based on these assumptions, I then figured out the amount of time I would need in order to get there.

It is also important to have a plan B and even plan C in action, in case your assumptions don’t turn out as expected. The value of a job income cannot be overlooked. For example, a source of $100 in monthly income is equivalent to $30,000 - $40,000 invested at 3%- 4%. This should be something you enjoy however, and are passionate about. So if you enjoy doing taxes and learning how much others make – you might be a tax preparer between January and April every year. It is up to you to figure out what you can do. However, I am not going to tell how to spend your time in retirement, so I am going to end the discussion here.

One obstacle to my plans could include situations where I lose my primary job, and am unable to find another one after that. This could damage my ability to make future contributions, and would also prevent me from reinvesting distributions, as I would be using them for my day to day expenses. Another obstacle that could prevent me from achieving my goals include situations where I can find fewer securities that fit my entry criteria. After a relentless increase in 2013, it is getting to a point where quality dividend companies are tougher to find. I do not envy the dividend investor who is just about to start putting their hard earned money to work today.

However, all hope is not lost, as I do find quality at decent prices today. The types of companies that look priced fairly include:

McDonald’s Corporation (MCD) franchises and operates McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. This dividend champion has increased dividends for 38 years in a row. Over the past five years, it has managed to raise them at a rate of 13.90%/year. Currently, the stock trades at a P/E of 17.30 and yields 3.40%. Check my analysis of McDonald'’s for more information.

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. This dividend machine has increased dividends for 5 years in a row. Over the past five years, it has managed to increase quarterly dividends by 15.40%/year. Currently, the stock trades at a P/E of 15.70 and yields 4.60%. Check my analysis of Philip Morris International for more information.

Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. This dividend champion has increased dividends for 26 years in a row. Over the past five years, it has managed to raise them at a rate of 9%/year. Currently, the stock trades at a P/E of 9.90 and yields 3.30%. Check my analysis of Chevron for more information.

Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has increased dividends for 46 years in a row. Over the past five years, it has managed to raise them at a rate of 21.40%/year. Currently, the stock trades at a P/E of 16.70 and yields 2.70%. Check my analysis of Target for more information.

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide.This dividend champion has increased dividends for 39 years in a row. Over the past five years, it has managed to raise them at a rate of 14.20%/year. Currently, the stock trades at a P/E of 15 and yields 2.40%. Check my analysis of Wal-Mart for more information.

Full Disclosure: Long MCD, PM, CVX, TGT, WMT

Relevant Articles:

Complete List of Articles on Dividend Growth Investor
The Security I Like Best: Philip Morris International
Dividend Investing Goals for 2013
My dividend crossover point
My Retirement Strategy for Tax-Free Income

11 comments:

  1. Figuring out the right mix of taxable and tax-deferred contributions is difficult. Taxes are likely the largest expense that most people have, I know they were my largest expense. I'd love to shelter more of that money, but I also want to reach FI through my taxable account as soon as possible as accessing the funds is so much easier. Looks like you're on the right track and with additional contributions to your taxable account you'll probably be able to hit FI with some cushion a bit earlier.

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  2. This is great - I am just now beginning the process of analyzing when I think I can become FI. It has only recently become a serious goal for me, so I'm looking at a much further horizon than 2018, but that's ok. One thing I will begin tracking is % of monthly expenses covered by dividend income. Right now this is a very low number, but I anticipate being able to grow this rapidly.
    Thanks again for sharing your goals!

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  3. Congrats on your great process towards your goal! If all goes well, will you change your investment strategy once you get to 100% expense coverage? After you end accumulation phase and no longer reinvest, you'd still be getting your 6-7% dividend increases, meaning you'd be outpacing inflation forever. Would you use this buffer to change your asset allocation (less stocks)? Or, could you trade in some future dividend growth for higher current yield, and hit your 100% target even sooner?

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  4. Hi PIP,

    It is insane how much taxes we pay. Especially marginal tax rates are ridiculous. For early FI ( before 55/59), it might be best in taxable accounts. One can also go the tax-deferred route, but would have to jump through some hoops to spend the income in retirement.

    Matt,

    I would have saved for a long time prior to that date. And I also never had any consumer/student debt before that, so I always have had a positive net worth ( albeit very small in the beginning) The toughest part is living my life now, while also aggressively saving and investing for my future.
    Do not be discouraged by small starting amounts. Over time, with savings, reinvesting, and time, your snowball will start rolling my friend. As long as you are motivated to achieve FI, and you work diligently towards that goal, you have a high chance of succeeding

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  5. Anon,

    Great question. I honestly would not be opposed to having some allocation to fixed income. This could be either bonds or just a stack of cash covering expenses for 2 years, sitting in a high yield savings account. Given the environment today, I doubt this would happen soon.

    Other than that, I do not see myself changing my strategy. One thing is that the 6-7% growth is on average, and is probably not going to be a linear growth like clockwork. So while I might be outpacing inflation, I also want to build another buffer in case the stocks I picked stop growing dividends as a group. That way, I would have some buffer until inflation catches up.

    I think I am biased against high yielding stocks in general, so at this time I would not think I would chase yield over growth. But, if I have no other option, I might do it anyway. So I guess it could be an option, so I should never say never.

    I think about risks all the time. I have inflation, rising health costs, investment risks etc. The risk I am not very well covered from is deflation.

    I might also keep my licenses current, in case I would have to get back to work. I imagine after 5 - 10 years without a job however, it would be almost impossible to find work. Of course, if I went back to school and received another degree, I would probably be able to find something.

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  6. What is your current profession?

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  7. Hi,

    I am a business consultant/analyst. I make ordinary income, but save a lot.

    The goal is to avoid bad debt all my life. Plus, I drive a 13 year old car.

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  8. Thanks so much for the Dividend Growth Investor blogs. I read each one eagerly. Really appretiate what you are doing. Congratulations and good luck !

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  9. DGI, like you, I expect far more of my contributions to be made into tax deferred accounts like a 401k, and less into my taxable accounts. Unfortunately given I dont have access to dividend funds in my 401k or the ability to self select stocks, this is going to mean a reliance on a 401k index instead. I'll be reliant on growth in income from my existing taxable portfolio to really generate significant dividend income gains going forward.

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  10. My goal for 2014 is to produce 1k per month in "monthly dividend income" and 24k per year in total dividend income.

    Bill in San Diego

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  11. "Because I would be earning more than what my typical monthly expenses would be, I would be paying taxes on the buffer income I won't be using."

    I don't understand this statement. You pay taxes on all your income, no matter how you use/don't use it.

    An important point you've left out, and a point that I need to analyze, is that dividend income from a taxable account is untaxed (the tax rate is zero) if your earned income is below a certain level. This is a real encouragement to retire early. I don't know if this continues to hold true when you start taking IRA distributions, which are taxed at regular income rates.

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