Monday, January 9, 2012

My Dividend Retirement Plan

I invest in dividend stocks, in order to generate a sufficient income stream, that would meet and exceed my expenses in retirement. Retirement to me is the point where my dividend income exceeds my expenses, which means that I no longer have to work for money. I am a big proponent of value investing, which is why I would only consider myself financially independent whenever the dividend income stream generated by my portfolio exceeds 1.5 times my annual expenses.

In order to get there, there are several simple, but crucial principles I need to follow.

The first principle in building wealth through dividend paying stocks is to spend less than what you earn. I have consistently managed to save approximately half of my after-tax income every month. In addition, any bonus or raise received has been designated to my dividend growth portfolio. It also doesn’t hurt to try looking for additional income opportunities, which are dependent on my skillset. By investing as much as possible, I can grow my portfolio and the income stream it produces very quickly. In addition, by spending half of my salary for example and keeping expenses low, I would only need 50% less than what I currently make in terms of dividend income. In addition, regular saving helps me to consistently add to my portfolio. This regular dollar cost averaging over time into positions that are attractively priced, creates another layer of safety.

The second principle is to invest your money very conservatively. I invest my money as if I would lose my job and I would have to depend on my portfolio income for my sole purpose of survival. As a result I do not chase hot stocks or try to outsmart the market through frequent trading or market timing. I have designated a simple strategy, which fits my personality and which works for me. Since I have designated the strategy, and since I have had years of experience in the markets, I know when to look for an investment opportunity. I do continuously try to learn as much as possible about markets, investing and other strategies, in order to find ways to improve.

The third principle is somewhat similar to the second. It is all about designing an investment strategy and sticking to it for most of the part. My strategy entails:

1) Stocks that have a 10 year record of consistent dividend raises
2) P/E ratios of less than 20
3) Dividend payout ratios of less than 60%. For MLPs, REITs and Utilities I evaluate each opportunity on an individual basis
4) Dividend yield exceeding 2.50%, although I do change this requirement depending on the dividend yield on the S&P 500
5) Quality characteristics such as wide moat, strong competitive advantages, strong brand names, rising earnings, decreasing number of shares etc

While I mostly stick to my strategy, I sometimes do deviate from it. I have purchased companies yielding less than 2.50%, or ones which have had less than 10 years of consistent dividend increases. I have not purchased stocks whose P/E ratio was above 20 times earnings however. Valuation is paramount in my investment decision. I typically expect that the distributions from my dividend portfolio would grow organically by about 6% per year. In comparison, dividends on Dow Jones Industrials Average grew by over 5% per year between 1920 and 2005. The rising dividend stream will maintain purchasing power of my income stream by protecting it from inflation. The types of companies I invest in include such blue chips like Johnson & Johnson (JNJ) or PepsiCo (PEP).

The fourth principle involved selling underperforming shares. While I take a great amount of time analyzing companies and making sure they are priced right before I purchase them, I realize that things could change and that I should not be married to a stock that does not deliver results. In a previous article I mentioned that typically sell dividend stocks only after three events have occurred. One of these events includes dividend cuts. If a company whose stock I own lowers or eliminates dividend payment, I immediately sell and reinvest the proceeds into an investment from a similar sector that is priced attractively. For example, when I sold British Petroleum (BP) in 2010, I immediately purchased shares of Royal Dutch Shell (RDS/B). As a result, I was able to replace the dividend income to a certain extent, and still had exposure to the Energy sector.

The fifth principle is all about diversification. I try to maintain a diversified income portfolio, which has over 40 individual securities in it. The portfolio is not equally weighted, as it has been built over a long period of time. It includes a fair amount of underweight positions, which were accumulated when they were attractively valued, but are no longer fairly valued. Examples include Family Dollar (FDO) and Yum! Brands (YUM). The reason behind diversification is to ensure that the income stream is not severely affected when one or two of the stocks I own cut distributions. A dividend cut in a portfolio of less than 10 stocks will severely affect the income stream. A dividend cut in a portfolio of over 30 stocks will not affect the dividend income. In an equally weighted portfolio, even if the dividend is completely eliminated in one or two components, the total income can still grow if the other components grow distributions and if the sold stocks are replaced strategically.

The sixth principle of my wealth accumulation strategy is strategically reinvesting dividends. While I plan that my dividend growth portfolio will generate organic dividend growth of 6% per year, by reinvesting dividends, I can generate a much higher total growth in portfolio distribution income over time. Basically I am turbocharging my total dividend income by purchasing shares which rise dividend payments, then reinvesting these dividend payments and also adding new capital to the portfolio every single month. I typically wait for the amount of dividends and the amount of new capital to reach $1000 before I purchase a new or additional position in a given company. I do not automatically reinvest dividends, because I do not want to purchase additional shares in a company that overvalued.

In summary, by saving money, investing them in blue chip dividend growth stocks and reinvesting dividends and new capital, I plan to generate enough dividends to make me financially independent. I follow the six principles in my wealth accumulation and dividend income generation. My dividend income is getting closer to 40% - 45% of my expenses, after following these guidelines for a several years. In a few short years, my dividend income should be able to exceed my monthly expenses, without having to endure a lower standard of living.

Full Disclosure: Long FDO, RDS/B, JNJ, PEP

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  1. You have an excellent approach. With the wave of retiring baby boomers shifting assets to seek income your approach,in addition to achieving the income goal, may very well produce exceptional performance relative to standard benchmarks.

  2. A thumbs up for investing conservatively. Those who got hurt the most during the lost decade were the ones who took unnecessary risks.

    From my backtests, those who invested in defensive, low-beta stocks, actually beat the market handily.

  3. Excellent post. Your strategy is very similar to mine, but you have expressed it more clearly and succinctly than I could probably do. Best of luck in 2012 and beyond!

  4. Can you comment on your frequency of purchases, your discount broker, and how those fees impact or determine your investing?


  5. That is awesome, I loved reading that.

    You are an inspiration.


  6. Excellent, this is the kind of thing I have been wanting to hear, your strategy in a nutshell, very good! I had especially wanted to know if you reinvested dividends by DRIP and you answered that. I hold about ten of your recommended stocks, all were picked before seeing your blog, which I now read regularly. I always make sure I choose stocks that beat the S&P over a long time period, and I always read the annual report before investing a single buck.

    Do mutual funds (for more diversification) or bond funds (for static income) play a part in your investing at all?

  7. Do you have any recommendations on trading accounts? I have to assume that since you are investing long term, you've settled on using someone who'll be around a while like iTrade or Questrade.

    For someone starting out here, do you have any recommendations on setting up an account and how to initially structure a portfolio (say with $5000).

  8. Don't you think you could retire a lot sooner if you took advantage of an IRA? The tax advantages are so great, and if you are planning to retire early, there is no penalty on doing so as long as you keep taking distributions until you are 60. Seems like a big mistake to not take advantage of that.

  9. Love it. Thanks for what you do!

  10. Your strategy sounds good. The KEY is sticking to the plan and keeping expenses low. I enjoy reading investing philosophies. What do you think about etfs that try tonfollow your metrics such as PID?

  11. I have been using a similar approach except I let all the dividends reinvest automatically and pay no fee. I have many of the same investments that you own all in IRA/401k accounts. My only exception is that I hung onto a couple of non-dividend growth stocks such as AAPL & ISRG.

  12. This is a great article! I agree with most everything here and you state it very clearly. Although reading online articles are great, I would also like to have a face-to-face conversation. Does anyone know to find an investment adviser offering good dividend growth investment advice? I'm not sure how to find one in my town.

  13. Kelby,

    I think you want to look for a independent advisor in your area that works for a flat fee or commission, according to the size of your portfolio. Such persons don't push certain stocks, but design a investment plan for you. You could tell them that you wish a dividend growth portfolio and have a discussion about it. There is much info online though, I'll bet you will pay them to find you stocks that are common knowledge, such as those recommended in this fine blog and others.

    Good luck to you!

  14. Nice write up but I'm curious about your thoughts on RDS since it hasn't raised it's div since Q2 2009?

  15. Nice strategy. Good luck with that.

  16. Excellent post! I have been implementing this strategy for about 8 years now. It works very well for me. I just want to add, as advice, to subscribe to a dividend stock newsletter. I am getting very good tips from them. Other than that, this article is right on for someone who is serious about financial freedom...

  17. I like your strategy as well. Keep up the good work for us.

    I am also curious about trying to balance dividends across the year.

    Although I am just getting started, my portfolio throws off almost $12K/year but I can't seem to get a good balance. 9 months of the year I have anywhere from $1100 to $1400 in dividends. But for 3 months of the year between $200 and $400.

    And as I get closer to retiring (60 now) I will want the dividends to throw off a relatively level amount of income.

    Have you given any thought to this in your planning?



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