Dividend Growth Investing Strategy For A Better Retirement

Retire Better With A Dividend Growth Investing Strategy

The Challenges of Planning for Retirement

Planning for retirement is a daunting task.  There are many things to consider when thinking about retirement.

How much should I save?  What should I invest in?  Will I run out of money?

Often times it can be so overwhelming that many people fail to even plan at all!

Or possibly since they know they should be saving something for retirement but don’t know how much, they will just begin putting aside some random amount invested in some random mutual or index funds without really figuring out the right approach to be taking.  These people are mostly just living with hope.  Hope that they are putting away enough so that one day they will be able to quit their jobs.  Hope that they are saving enough so that they won’t run out of money during their golden years.

Certainly this is better than doing nothing, but there is definitely a better way to go about reaching all of your retirement dreams.

The Problems with Traditional Retirement Advice

Traditional retirement advice often tells people to save some random amount of their annual income (5 or 10%) and invest it in a select group of mutual funds or index funds.  This advice is very general and not personalized like retirement planning should be.  This will most likely lead the hopeful retiree to either not save enough and run out of money during retirement or to not save enough and realize they have to work longer than they had planned.

Another often heard advice regarding retirement is the 4% rule.  The 4% rule allows that a retiree can withdrawal 4% from their retirement savings (adjusted for inflation after the first year) each year to cover living expenses.  The retiree will do this by pulling out any income earned from the investments and selling some investments to cover the difference.  The idea is that a 4% withdrawal rate is safe enough that the investor should/possibly will have enough money to last until they pass away.

Unfortunately, there is a few big problems with the 4% rule.

  1. The biggest problem is the fact that there is a possibility that you will run out of money while still living.  I’m not sure about you but the last thing I want to worry about in retirement is whether or not I am going to outlast my money.
  2. A second problem is that the 4% rule requires investors to sell off investments at inopportune times.  When the market is down and investments are undervalued is not a good time to be selling.
  3. Another problem with the 4% rule is that it requires you to draw down your assets.  Each passing year your nest egg will get smaller and smaller as you use it to cover your expenses.  At the end there will be little if anything left to pass on to your heirs or favorite charities.

Fortunately, there is a better strategy for planning for retirement.

Dividend Growth Investing and a Better Retirement

Dividend growth investing is a great strategy to use when planning for retirement.

Hopeful retirees should calculate the amount of income they believe they will need during their first years of retirement.  You can do this by tracking your expenses and projecting out which expenses you will have during retirement and estimating how much money you will need to cover those expenses.  Our retirement calculator uses a budget in today’s dollars and provides an inflation adjusted budget by year. Be sure to give yourself a buffer so that you don’t fall short when unexpected surprises pop up.

Determining How Much You Need in Dividends

Once you have a fairly good estimate of how much annual income you will need in your first couple years of retirement, you can calculate a goal for how much of a nest egg you should aim to accumulate.  For example, let’s assume you estimate that you will need $45,000 in income during your first year of retirement.  Now if we can put together a dividend growth portfolio that is yielding 3.75%, you will need to have a nest egg off $1.2 million (1,200,000/.0375=45,000).  If your portfolio is yielding more, you will need a smaller nest egg.  If it yields less, you will need a larger nest egg.

This gives us a fairly reasonable goal of how big of a nest egg we want to try to accumulate in a dividend growth portfolio by the time we are ready to retire.

So if we decide that we need $1.2 million for retirement, we can figure out exactly how much we should be saving/investing each year from here until we plan to retire to reach this goal.

The investor will want to work towards this goal and if accomplished will have a solid foundation built for a great retirement.

A dividend growth retirement eliminates all of the problems with the traditional 4% withdrawal advice.  Specifically:

  1. Dividend growth investors will be living off of the dividend income received from the companies they own.  Therefore, they will not need to worry about running out of money because they are not selling their investments to offset expenses.  Instead their portfolio is earning an income (growing each year at a rate faster than inflation) which will be able to cover all of their expenses.
  2. Since the dividend growth retiree is not forced to sell any of their investments, they won’t be selling at the wrong times.  A dividend growth retiree won’t need to sell any of their investments unless one of their companies cuts or eliminates their dividend payments.  In that situation the retiree will want to react by selling off those shares and finding an alternative dividend growth company to own in its place.  Most of the time, dividend growth investors will be long term holders of their companies and won’t be selling.
  3. Since the dividend growth retiree does not need to sell off their nest egg to cover expenses, they will have a large amount of wealth in which they can pass on to their heirs or favorite charity organizations.  You’ve worked hard to accumulate that nest egg, do you really want to watch it all dwindle away and have nothing to leave behind when you pass?

dividend growth retirement plan can be a great investment strategy when it comes to securing your financial future.

Increasing your portfolio diversification

Portfolio Diversification – Improving Your Portfolio With Every Purchase

Every time I make a new investment I am looking to improve my overall portfolio.  There are 3 key measures that I look at in which a dividend growth stock purchase may improve my investment portfolio.  A new buy may improve my portfolio by increasing overall diversification, increasing my current dividend yield or by increasing my dividend growth rate.  Every single time I make an investment I look to improve the portfolio by at least one of these metrics.  If a purchase helps me in more than one metric, then it is even better.

Increase Portfolio Diversification

Diversification involves reducing risk by investing in a variety of assets.  For your overall financial picture this will involve investing in different assets such as stocks, bonds and real estate.  For dividend growth stock investing, diversification involves investing in companies from different industries.  You may want to invest in companies from the oil industry, retail industry or restaurant industry.  There are many industries available to invest in which will aide us in our attempt to diversify our dividend growth stock portfolio.

When I look to make an investment I always look to see what industry the company operates in.  Then I look over my portfolio to determine if I already have investments in that particular industry.  If I do, how much of my portfolio does that industry make up.  I don’t want to have all my stock investments be from one or two particular industries.  For me the more industries I can invest in the more diverse my portfolio is.  With higher diversification my portfolio will have less risk.  This is because not all industries will be affected the same way by different market conditions.  If the oil industry is really suffering, my oil stocks may be going down.  However, my stocks from other industries may still be doing alright or even wonderful.

Increase Portfolio Dividend Yield

Another way I may look to improve my portfolio is by investing in stocks that will help increase my portfolio dividend yield.  One of the goals in a dividend growth investing strategy involves bringing in dividend income.  If I can increase my overall portfolio dividend yield, then I am increasing the income that I am being paid by my companies.

For example, if I have a portfolio of dividend growth stocks that is worth $10,000 and I expect to receive about $350 in dividend income this year then my portfolio dividend yield is 3.5% (350 divided by 10,000).  Now when I am looking at new investments I know that if I invest in any stock currently yielding higher than 3.5% it will raise my overall portfolio yield.  If I decide to invest in a company that is currently yielding 5% then I will increase my portfolio yield.  Let’s say I invest $1,000 in a company yielding 5%.  I will expect this company to pay me $50 in dividend income this year.  My new portfolio dividend yield will increase to 3.64% (400 income dividend by 11,000 portfolio).  This is good because on the whole my portfolio is earning me more income for each dollar invested.

Increase the Dividend Growth Rate

Another way to improve your overall portfolio with a new investment is by increasing the dividend growth rate of the portfolio.  The dividend growth rate is the rate that a company increases their dividend payment from one year to the next.  The higher the dividend growth rate, the faster my dividend income will increase.  If my entire portfolio is invested in companies that don’t increase their dividend at a high rate each year, then I may improve the portfolio by investing in a company that has been growing their dividend quickly over the past few years.  This will increase my total dividend growth rate and help me increase my income quicker.

For example, if the companies in my portfolio are averaging 8% dividend increases annually, I may look for a company that has been increasing their dividend faster recently.  If I then invest in a company that has been averaging 15% dividend increases the past few years, I will expect my overall portfolio dividend income growth rate to increase slightly.  A higher portfolio dividend growth rate means that my income will be growing faster.  I always want to make sure my portfolio dividend growth rate is higher than the rate of inflation.  Ideally I look for a portfolio dividend growth rate of at least 7-8%.

In Conclusion

With every purchase I look to improve my portfolio in one of these three ways.  The more ways I can improve my portfolio the better.  Dividend growth stock investing involves a balance between diversification, current dividend yield and dividend growth rate.  We want to make sure we have a good mix of companies to help decrease overall risk of the portfolio, a good current yield so that we are getting an acceptable income and a good dividend growth rate so we know that income is increasing.  Getting the perfect balance for your portfolio is more of an art then a science.  By trying to improve at least one area with every purchase, you will be sure to keep your investment portfolio heading in the right direction.

financial goals for dividend investing strategies

Financial Goals of Dividend Investing

When you decide that you want to become an investor, one of the first things you must do is map out your goals.  Figuring out what goals you want to achieve with your investments will help you determine what type of investing you should do and what strategy you may want to use.

Your Goals are your Investing Guide Map

Your goal in investing is going to be your mission statement.  The goals you set will help be a guideline for your investment decisions that you make in the future.  When setting your goals, make sure not to be vague.  Most people that are investing are obviously out to make money.  The question is why are you trying to make money through investing.  Maybe you want to invest in order to gain a higher return on your money so that you may be able to afford something in the future.  Possibly you are investing so that you can build up a passive income from rents, interest and dividends to spend now or/and in the future.  Whatever you decide, be sure to write out a clear goal statement and focus on it frequently as you advance through your investing career.  Modify your goal if and when things change.  Remember that it is OK if what was once your goal has now changed and you find yourself trying to achieve something different.  Just make sure to formulate your investing plan with your goals in mind.

Dividend Growth Stock Investing Goals

There are a few different goals you may be interested in pursuing where a dividend growth stock investing strategy is a suitable approach.

Building a passive income from dividends for current needs

Rather then spend all your money from your paycheck, you may be interested in investing some money each month in dividend paying stocks.  This will allow you to build up an investment portfolio over time and provide some supplemental income if you decide to take the dividends in cash to spend as the companies pay out.

Building a passive income from dividends for future needs

You may decide that you don’t need more of a current income to meet your current needs and wants.  However, you don’t plan on working forever and someday that paycheck will quit coming in if you quit working.  Building a portfolio of dividend growth stocks is a good way to build an income for the future.  You can grow your portfolio quicker by reinvesting your current dividends and eventually the annual dividend income may be enough to cover your living expenses.  At this time you can afford to not have to work for a paycheck and just live off of your dividend income.  This is a good strategy for retirement.

Preserve investment capital

When you are looking for a safe investment to keep your money safe most people will thing of bonds.  While bonds will help keep your principal safe, they don’t offer much in the way of investment returns.  Another option if you are willing to take on a little more risk is dividend paying stocks.  Stocks are definitely a riskier asset class then bonds.  However, dividend paying stocks have typically been less volatile compared to other stocks.  Dividend paying stocks offer a decent income component and if you select your investments wisely will give you better preservation of your capital then non dividend paying stocks.  Compared to bonds, dividend paying stocks may be a little more risky in that you can lose some or all of your investment.  However they also typically offer greater returns then you would receive by investing in bonds.

Good returns

Financial Risk Tolerance vs. Emotional Risk Tolerance

There have been studies that have shown that dividend paying stocks tend to outperform over time non dividend paying stocks.  Also companies that annually increase their dividend payments tend to outperform companies that do not increase their dividend payments.  So over the long run, we can hope that we will be getting the best return in the market from our dividend paying stocks of solid well known companies.  You will probably be less likely to lose your money and earn a decent return from a Coca Cola type company compared to a company that you have never heard of and don’t understand how they make money.  Dividend growth investors pick solid stable companies that have a history of increasing earnings and paying out increasing dividends.  These companies perform well over the long run.

My Dividend Growth Stock Investing Goals

Personally, I am investing in dividend growth stocks for all the reasons I’ve listed above.  I believe that dividend growth stocks will over time give me a great return with less risk to my investing portfolio.  I understand that dividend growth stocks will pay me out an income this year that I can use for expenses if needed.  My main goal when investing in dividend growth stocks is to build up a portfolio that will provide me with a sizable income later in life.  I am 30 years old and have at least another 30 years of working for a paycheck.  However, I’d like to build up a portfolio of dividend stocks that eventually will pay me enough income that I can retire if I want.  I will be able to use the income from my portfolio to pay my expenses without ever having to sell any of my stock assets and decrease my portfolio.

So for my goal I have a long journey ahead of me.  Short term I measure my success by tracking my dividend income on a monthly and annual basis.  I expect to see these income numbers rising as time passes and if this is happening I will know I am on the right track towards achieving my investing goals.

In Conclusion

Before you get started investing, make sure to take a moment and think about what you are really trying to achieve.  Figure out your goals and use them as a guide map for your investing decisions in the future.

Companies To Invest In – 3 Principles To Follow

Investing means giving up some of your money now with the expectation of getting even more money in return in the future.  Did you catch that?  Money.  Investing is about money. The bottom line when it comes to investing in stock (or anything else for that matter) is that you want a company that can profitably convert its goods and/or services into cash, lots and lots of cash.  Well, isn’t that incredibly obvious?  You would think so, but when it comes to identifying companies to invest in, it can be oh so easy to take your eye off the ball.  Following are 3 principles that can help you to avoid getting distracted and maintain an investment-oriented focus for deciding which companies to invest in.

3 Principles For Finding Companies To Invest In

Principle #1 – Don’t Confuse Investing With Donating to a Cause

When considering investing in a company’s stock it’s vitally important to distinguish between evaluating the company vs. considering the companies valuation.  To evaluate a company means to consider its overall suitability as an investment and to otherwise determine whether you’re comfortable with it.  In other words, I don’t ever recommend investing in a company if you have a problem with the kind of business they’re in, or the goods and services they produce.  For example, if you think smoking is bad for society then by all means don’t invest in a cigarette company, no matter how well you might think the stock will perform.  Having said that, once you’ve evaluated a company and determined that you don’t have any ethical or moral problems with its business, it’s then time to consider the valuation of the company, or how much it’s stock is actually worth in dollars.

“Find Companies To Invest In That You Don’t Have Any Ethical or Moral Problems With It’s Business”

This is an important concept, because people sometimes confuse investing with donating to a worthwhile cause.  For example, if a company is pursuing green initiatives such as clean energy, there are certain people who will almost blindly pour money into it.  Is that a wise or unwise use of money?  It depends.  If your intention is to “invest” in a clean energy company without a thorough analysis of its business prospects then you’re acting unwisely because remember, when investing, the question you’re asking is not whether a company can save the world, but whether they can bring their products to market and generate a pile of cash in the process.  On the other hand, funding a clean energy company can be a good use of your money even though it may be years away from producing a commercially viable prototype if your primary intention is to help the environment and profit is an afterthought (or not a consideration at all).

In summary, when looking for companies to invest in I think we would all like to invest in companies that both benefit society and would make us a lot of money in the process, but the reality is that such investment opportunities are few and far between.  In other words, most companies aren’t out there saving the world, but they’re not destroying it either.  Instead, they’re usually somewhere in between, trying to make as much money as they reasonably can by selling their products and services within the confines of the law and their business practices.  For that reason, my recommendation is that if you intend to use your money to donate to a cause that will help society then by all means do so, but temper your expectations of getting anything (or even nothing) in return.  On the other hand, if your intention is to invest in a company’s stock with the expectation of a solid financial return, make sure to keep your focus on the profit generating aspects of the company.

Principle #2 – Investing is About More Than Products, Services and Technology

Again, investing is about making money; it’s not about products, services, or technological advances in and of themselves, no matter how groundbreaking, novel, beneficial or noteworthy they may be.[1]  To illustrate, I was once doing onsite professional work at a company.  During one visit I noticed that an employee had a yellow sticky affixed to their computer on which they had written the most popular, trendy dot.com companies of the day – companies whose stock had skyrocketed even though they had no proven profit-making business models.  We talked for a minute and I said, “I noticed you’re a big fan of dot.com companies.”  The person said yes, and that they were an enthusiastic investor in them, to which I said, “Aren’t you concerned about the high valuations of these companies, even though they’re not making money?”  To that the person said, “It’s not about valuation, it’s about revolution.”  Upon hearing that my immediate thought was, “SELL!  Everybody sell your dot.com stocks now!”

Why my reaction?  Because it became clear to me that the whole dot.com-induced investment mentality had become so enamored with the life-changing technologies bringing on the Information Age that it had become unhinged from financial reality.  But like any other law, financial reality cannot be defied forever, and not that long afterwards the vast majority of the dot.com’s burned through the remainder of their cash and crashed in spectacular fashion, leaving only those companies that had focused on realistic, workable, and sustainable profit-generating activities (Amazon and eBay, for example).  The lesson?  Remember that investing is not-about the products, technology, or services of a company, but whether a company can covert its products, services, or technology into more money (profit) than it costs to generate those products, services or technology!

Principle #3 – Don’t Buy into the Hype (or sell due to a lack of it)

Companies To Invest In BubbleWhen deciding which companies to invest in you may begin to notice that companies can be hip one day with a high-flying stock price and fall out of favor the next leaving their stock in the tank.  Does that make sense?  Does the financial outlook of companies really rise and fall so quickly?  While it is possible, in the short-term a company’s stock (and the market itself) can frequently be driven by a herd mentality.  Warren Buffet has a great quote that summarizes this concept: “In the short run, the market’s a voting machine, and sometimes people vote very non-intelligently.  In the long run, it’s a weighing machine, and the weight of business and how it does is what affects values over time.”

In other words, over the long haul investing isn’t a popularity contest.  No, in the end investing is about substance (or “weight”), or how much profit a company can churn out over time.  So don’t get caught up in the hype and buy into a company just because it’s the latest market darling (you’ll likely buy too high), and don’t abandon ship just because a company is getting beat up in the media for making an understandable mistake (you’ll likely sell too low).  Instead, step back, get some perspective, consider the big picture, and base your investment decisions on a company’s medium and long-term profit potential.

Summary of Companies to Invest In

When you boil it all down, all well-run companies have at least one thing in common: they’re trying convert their goods, services, and/or technology into as much cash profit as they can in accordance with the law and their overall business principles.  In other words, at their core, companies (or any other kind of investment) are capitalistic, profit-centered money-making machines.  If you don’t remember that then I don’t think you can ever properly judge the actual monetary value of a company’s stock.  So, to maintain that investor-oriented focus, keep the following 3 things in mind:

  1. While reviewing companies to invest in don’t invest in companies that you have moral or ethical problems with, but don’t confuse investing (making money) with donating to a cause (benefiting society).
  2. Investing is about more than products, services or technology; it’s about efficiently converting products, services and technology into cash.
  3. Investing isn’t a popularity contest; it’s about substance in the form of profits.

[1] Also, don’t automatically dismiss as an investment opportunity what may on the surface appear to be mundane or “boring” company.  Fortunes have been made in the garbage collection business, and Gillette has made billions by cranking out massive quantities of sharp little strips of steel called razor blades!