Monday, June 23, 2014

Multi-Generational Dividend investing

You have spent your whole life accumulating your nest egg. Building a long term dividend portfolio takes a lot of time, effort and a little bit of skill or luck. Once the dividend machine is set up properly however, and starts throwing off a sufficient stream of income, investors would have to spend less than 10 hours/week on managing investments. This is not a huge time commitment, but it provides investors with the ability to make changes if stories do not work out as expected. Investors, who looked after their income portfolios in 2007-2009 bear market, would have been able to dispose of their securities in a timely manner after they cut or eliminated dividend payments.

The question is however what happens if the individual/s who built the portfolio from scratch cannot afford to manage the investments anymore. This could be due to several reasons including death, incapacitation or other gruesome events. As dividend investors, we tend to focus on selecting companies that would generate income for decades, but do not spend a lot of effort on who would be the next one in the family to maintain and manage the portfolio. Selecting a beneficiary for your online brokerage accounts is just a small step in the process. Writing a will which lists all online accounts is another small step that should be done, in order to avoid having inheritors scramble to locate assets after an unfortunate event.

These unfortunately still do not answer the question of whom and how the income portfolio would be managed. There are several potential options, each coming with its own set of risks.

-The first is to just hold on stocks, don’t do anything , except for maybe sell after dividend cuts. I have noticed that many companies tend to raise dividends for long periods of time, and then freeze them, only to continue raising them again. Kellogg (K) is a prime example of this, as it ended a four decade streak of annual dividend raises in 2000, only to start boosting distributions again nine years ago. One piece of research I find particularly telling is the work that Jeremy Siegel has done on the performance of the original S&P 500 companies in 1957. He found that a portfolio of these companies, where investors did absolutely nothing, except for reinvest dividends and reinvest cash proceeds from acquisitions in the portfolios, would slightly outperform over the next 50 years.

- The second thing to do is to educate family/close ones, in order to ensure they can manage investments without a considerable input from outside help. The goal is to make family members motivated enough so that they can manage money and are interested in making it last for several generations. If family members are not motivated, chances are the amounts of money will be spent quickly, leaving little behind in a few short years after the original accumulator is no longer in charge. As a result, creating a trust fund where only the income could be spent might be the best solution. This would require some help from an attorney, in order to set up the trust properly, and outline bylaws and trustee responsibilities.

- The third option is to hire someone to manage investments and focus on implementing your strategy. This could cost a lot, particularly if the wrong type of an advisor is selected. In addition, there has to be a process for selecting advisers in the future, since many would end up retiring on their own. You also need to decide how to avoid the future Madoff’s of the world.

- There is a fourth option, where one could simply place the money in mutual funds, and probably be just fine with that. However, going back to step two, if the beneficiaries are not properly trained to think about money, they can blow through the funds in no time. Alternatively, someone who has a large nest inherited nest egg and doesn't know a lot about investments can panic during the next bear market and sell. Thus the beneficiary could potentially undo decades worth of patient compounding by the original capital accumulator.

Overall, I believe that a relatively well diversified portfolio, consisting of several stocks from each sector should do well over time, even if managed passively. I believe in the living off dividends method, since this is a sustainable way to ensure that a nest egg can produce income to live off for decades. This is what has ensured success for charitable organizations and trust funds for decades. Examples of companies to include per each sector includes:

Yrs increase
10 yr DG
Fwd P/E

Information Technology
Johnson & Johnson
Consumer Staples
Procter & Gamble
Consumer Discretionary
Real Estate
Realty Income
United Tech

For my money, I plan on placing them in trusts that would distribute dividends only to beneficiaries for decades to come. The only decisions that would be done by a trustee would be about selling companies that cut or eliminated dividends, or distribute proceeds from companies that are acquired for cash by someone else.

What are you doing to ensure longevity of your nest egg, beyond your own generation?

Full Disclosure: Long K, IBM, AFL, CVX, JNJ, PG, MCD, O, UTX

Relevant Articles:

Living off dividends in retirement
Four Percent Rule for Dividend Investing in Retirement
Why Dividend Growth Stocks Rock?
A dividend portfolio for the long-term
How much money do you really need to retire with dividend paying stocks?


  1. Thanks for addressing this important topic. I also think that constructing a portfolio of dividend paying stocks in a taxable account needs to be thought through very carefully. I received my quarterly Vanguard SP500 fund dividend last week and the amount is up 9.69% over the quarterly payment from June 2013; results that seem to be not too far from your expectations. For me, the lowly, simple SP500 fund from Vanguard achieves what you trying to do in a way that any beneficiary or heir to my estate could easily manage. Never sell, all dividends are paid in cash. One of the best tax breaks that exists is the step up basis at death. Possibly hundreds of thousands of dollars in capital gains tax liability wiped out.

    If the dividend yield is not high enough, there are other Vanguard mutual funds whose yields are higher but likely the long term performance will converge to that of the SP500. International funds are yielding more and provide additional diversification.

    The point of all this is not to discount using low cost mutual funds to achieve a nice dividend stream and provide an easy transition to heirs.

  2. Hey DGI,
    I thought about who would be getting all of my assets and currently it is my parents. However if my parents pass away first I am left with no children to inherit the assets. I have to think about this because I am not close with anyone else in my family and they wouldn`t know how to manage my portfolio.

  3. I am going to try option 2 first. If I can educate my kids and wife on finances and managing investments they will reap the rewards and hopefully pass it on to their kids. If I fail at this I am going with your choice and putting it in a trust. This may be easier for my wife. When she is older I do not see her taking much interest in stocks.

  4. I also have to educate my wife and daughters so that they don't wipe out a life time's worth of savings. Great article DGI.

  5. I am a member of USAA. At my death and my wife, I have thought to put it all in the S&P500 dividend fund and pay out the dividends to all of our surviving beneficiaries. We are the only ones who know how we have made all this money and they are clueless about stocks.

  6. Thanks for the article. This is something I have thought about for quite some time, My Dad recently passed away at 91. My Dad's father passed away during the Great Depression when my Dad was age 13 (and the second oldest of 8 kids). This situation plunged my Dad and his family into poverty. My Dad worked hard all his life and managed to leave our immediate family in good financial shape. I don't want the same thing to happen to a future generation so I'll keep these suggestions in mind.

  7. I'm actively in research mode on trusts; the flexibility and choices are both wonderful and mind-numbing. I've spent hundreds of hours researching and by far the best book on the subject I've found so far is "Beyond the Grave". There is a new edition due out on 8/14/2014. I'd suggest it is a wonderful place to start your research.


Questions or comments? You can reach out to me at my website address name at gmail dot com.

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