Even so spoke the old farmer to his son: A cow for her milk, a hen for her eggs, and a stock, by heck for her dividends. An orchard for fruit, bees for their honey, and stocks, besides for their dividends…” John Burr Williams, The Theory of Investment Value, 1938.
My retirement strategy is based on living off dividends in retirement. Dividends are more stable, predictable and reliable than share prices. Over time, dividends tend to grow above the rate of inflation, making them a great source of income for retirees.
I believe that one can retire when dividends exceed expenses at the dividend crossover point. At that point, the retiree can remain retired by cashing in those dividend checks.
Note that this is a simplistic view, because retirees also earn pension income. That just means you need to generate less in dividend income.
The base model is to live off dividends in retirement and ignore share price fluctuations. If you base your spending based on dividends, and spend only the dividends, you are very unlikely to run out of money in retirement. Dividends also tend to follow current economic conditions, rather than some historical backtest. In other words, you are living off actual cash returns generated today, and know exactly how much your investments have generated for your, and how much you can spend.
We are of course talking about having a diversified equity portfolio.
My logical way of living off dividends is basically inspired by my general simple way of life.
I buy a house for the ability to live there. I buy a car for the ability to use it for transporation. I buy land for the ability to harvest crops from it. I buy businesses for their cashflows that I can use. Hence, I buy partial ownership pieces of many businesses for the cashflows from profits that their share with me.
All of this got me thinking if I really need fixed income for my retirement portfolio. After all, fixed income is sold to retirees as a way to smooth over share price fluctuations. But this is mostly for retirees who sell stock to cover expenses. I do not plan on selling stock in retirement and be exposed to the ups and downs of the stock market fluctuations. I plan on living off dividends. I focus on the stability of dividends, and make sure the portfolio that generates them is well put together. I do not care about stock price fluctuations, and hence I do not think I really need fixed income to help me stay the course during share price declines. That's because that fixed income also costs me in terms of opportunity costs and reduced dividend income and capital gains on stocks. Plus fixed income loses to inflation over time, and as retirees live longer they are also more exposed to longer cycles of inflation over time.
So if the portfolio generates $30,000 in annual dividends, and I need $30,000 in annual dividends to live off, I am retired. In the highly unlikely event that I have a Great Depression, I may experience some dividend cuts. But the Great Depression took 3 - 4 years to unfold, so if it did happen I could adjust, particularly as cost of living actually got cheaper too.
In the other modern day time, the Global Financial Crisis, dividends from a diversified portfolio also declined a little in 2009. Dividends actually increased in 2007 and 2008. But again, cost of living also got cheaper too.
These of course are extreme outliers that happened in less than 5% of years over the past 100 years. These are rare, but if they do happen, living off dividends still works. I could argue that by following spending based on dividends, one can adjust lifestyle in retirement quickly, and thus avoid guessing about whether they will run out of money or not.
This simple idea of living off dividends in retirement is logical. Living in retirement is similar to living during my work years. If I make $30,000/year when I work, the most I get to spend is $30,000/year. If I get laid off next year, and have to find a lower paying job making $25,000/year, I now have to live off $25,000/year. If I get promoted to making $40,000/year, I get to base my spending on the larger income. We are speaking plainly here, to illustrate a point, and not get into the nitty gritty ideas from here of course. Most of us who have accumulated some funds for retirement are actually living below our means, in order to save and invest consistently over many decades...
Let's take the basic model of living on income when working. When I generate $30,000 in annual dividend income in retirement, the most I get to spend is $30,000/year. It's simply logical.
Having that dividend machine generate enough money to sustain a comfortable retirement is therefore the item that generates our cashflows. The important part is to build it right, build it tight, and ensure you are building on a stable foundation. This means diversify accross sectors and industries, focus on quality, and make sure fundamentals are good and growing, while also avoiding paying too much of a price for these assets. Make sure you build some redundancies in place, such as margins of safety in valuation and in dividend coverage and in diversification accross industries an time.
After this lengthy introduction of some basic ideas, let's discuss what I am trying to ask myself mostly. Do I need fixed income?
Imagine that you own $100,000 worth of stocks today. You expect that your portfolio would generate $2,000 in annual dividends this year, which would also grow at or above the rate of inflation over time as well.
In other words, your would likely collect around $10,000 over the next 5 years and $20,000 over the next decade.
In other words, if I own $100,000 in stocks today, I also have a future claim to $10,000 in 5 years or $20,000 in a decade.
If we extend this period to 15 years, we are looking at a future claim of $30,000 and if we look at 20 years, we are looking at a future claim of $40,000.
That simple calculation took number of years we are waiting for and multiplied by a $2,000 dividend payment. I ignored inflation, but I also ignored the power of dividend growth, which has been higher than inflation over time. In other words, I was too conservative in this estimation.
Let's say I own $100,000 in dividend paying stocks. But I decide that I also want to have fixed income. Hence I sell $10,000, and buy a staggered maturity of bonds. Let's call it a bond ladder, where $2,000 mature each year for 5 years. Or we can sell $20,000, and have $2,000 maturing each year for 10 years.
You can see that we are getting a cash inflow of $2,000/year from these bonds maturing. I am ignoring interest, but I am also ignoring inflation as well. We will also be generating dividends as well.
Alternatively, one could own $100,000 in dividend paying stocks, and simply accumulate the dividends in cash over a period of time to get to the desired amount of fixed income. But I am questioning if I need fixed income at all. I believe in owning the machine that prints the cash, and value it highly; I do not really believe in just stashing cash itself, and lose to inflation, taxes and opportunity cost.
But I will get to my point now.
I believe that these future dividend income streams are ready sources of cashflows. They come at predictable time intervals, and I have somewhat of a predictable certainty as to their amount, timing and extent. While dividends are not liabilities, they are relatively certain to be paid out in the future and received by the shareholders.
Hence, I do not view the need for fixed income in a dividend portfolio. I do not need relative certainty of bonds that would provide income and maturity at certain times, because I believe dividend payments provide that, overall.
I do not believe I need fixed income, because I view those dividend payment streams as something as close to a fixed income substitute in terms of cashflows as fixed income. Though they are not they same.
We can argue that dividends are not guaranteed. However, if history is of any guide, dividends from a diversified portfolio are rarely cut. If you look at the data going as far back as 100 years ago, the only time that dividends declined were during the Great Depression, 1937 recession, 2008 Global Financial Crisis.
Also, dividends are much more stable, reliable and easier to forecast than share prices. They are less volatile than share prices. The best part is that dividends tend to grow above the rate of inflation over time. Bonds do not do that (unless we are talking TIPs of course, but they are a very small portion of the total bond market). The big risk with fixed income is that over time it does lose purchasing power. And inflationary shocks have been much more prevalent in the past 100 years than deflationary shocks.
Those dividends of course are derived from company profits. Under the current regime, in order for a company to end up with $2 in dividends per share for the year, they are probably making around $5/share in profits. So they earn that $5/share, and reinvest a portion in the business to maintain and grow their position in the marketplace.
Hence, if I own $100,000 of stock and expect say $20,000 in dividends over the next decade, I am effectively having an 80% - 85% allocation to equities and 15% - 20% allocation to fixed income. Albeit corporate fixed income, and not the Treasury Bills type that is Guaranteed by the US Government. While it's not guaranteed however, it's also slightly better because those cashflows from dividends are likely to grow above rate of inflation. And even during a Great Depression, they were still being paid.
If we go back to individual asset allocation, and personal financial circumstances, it is likely that ones overall financial picture is even more conservative. For example, if I was receiving $1,000/month in Social Security/Pension income, I am essentially the owner of an asset that's likely generating $12,000/year, which would likely be worth roughly $200,000, if not more. (my estimate for a cost of an inflation adjusted annuity that is government provided and secured for a male in their 60s under current interest rate regime, assuming it was available for purchase).
If I were still in the accumulation phase of course, fully employed and adding money on a regular bsis, I am basically underallocated to equities, even if 100% allocated to equities. I think of it this way - imagine I started work at 25, investing $1,000/month in equities. I would invest $1,000 in equities every month for the next 40 years. This means that by age 35, I'd have invested $120,000 in equities at cost, but have 30 more years worth of contributions (value of $360,000). On a lifetime accumulation basis, using simplistic math, I'm roughly only about 20% allocated to equities. This way of thinking could obviously crumble under a Great Depression type scenario with a 25% unemployment and a long several bear market. But it's nevertheless a useful model I have used for myself as I was building out my equity portfolio in the accumulation phase.Which actually included a few big bad bear markets along the way. With many more to come in the future, or so I am promised.
These are some random thoughts I am having, that I wanted to put down on paper.
The gist of it is that if I hold $80,000 of equities today and $20,000 in fixed income, I would roughly expect to receive $20,000 + cash from the bonds minus inflation and taxes over the course of say the next decade (as those bonds mature).
But if I held $100,000 in equities today, I would also receive something like $20,000 minus inflation and taxes over the course of the next decade.
While claims to cash for equities and fixed income have different priorities as to their payments, and terms do differ when we look at it at a granular detail level, they do not really differ as much when we take a big picture look. Under some scenarios, like Great Depression types, fixed income claims could turn out to be superior, especially in a deflationary type scenario.
Under many other scenarios however, fixed income claims could turn out to be inferior, especially in an inflationary type scenario. There is also a steep long-term opportunity cost to fixed income, under most scenarios as well. That $1 you keep in bonds could have turned to a lot of money if it were in equities instead. Under most scenarios that is of course.
Nothing is a one size fits all approach. After all, owning fixed income is an insurance against the unknown unknowns. Under most situations and scenarios, owning some fixed income could turn out to be an inferior strategy to owning 100% equities. However, under some circumstances, owning fixed income could provide some time in case things do not work out as expected.
There are pros and cons to everything you end up investing in. In a way, investing is like buying a house with or without insurance. If you hold that house for say 30 years, and it never burns down, you ask yourself "why did I waste all that money on insurance". I would have been better off never paying those insurance companies.
However, if your house does burn, you do tell yourself how lucky you are to limit losses because you have insurance. (sorry I am kind of upset about the loss of property and life in California with recent events, but don't want to upset you with my example)
So basically, my short answer is it depends. I try to think of trade-offs, and what could go wrong or right, and the path it takes to get there.
One could also give me the pushback of course that I am thinking of this after we had a 16 year bull market off the lows in 2009. I could also be tempting fate with this post. I doubt I would have written this post in March 2009. Though posting this in April 2025 does seem somewhat brave.
How did I come up with this idea in the first place?
I was thinking of a scenario, where someone is within 5 years of their projected retirement date. Under the dividend growth investing strategy, you can retire when your dividends exceed expenses. I do not really think one needs fixed income, unless they are saving for a particular near term expense over the next year or two or three. Fixed income is probably even less needed if one already gets social security/pension in retirement. One may argue that a one year's worth of expenses for an emergency fund should be in cash/short-term fixed income. Though I could also argue that this could be unneccessary as well.
However, if I had a portfolio that yields say 3% today, and I needed a 3% yield to cover expenses, I could theoretically have 5 years worth of expenses if I took those dividends in cash for say 4 - 5 years and put them in fixed income. I am ignoring the effect of compounding and new contributions for the sake of the argument I am trying to make in this article. But this is the type of thought process that led me to this article in the first place.
Traditional retirement strategies that rely on selling assets in retirement however tend to focus on minimizing share price fluctuations. Therefore, they are based on adding fixed income. This reduces "volatility" in portfolio values that is needed to smoothen out the journey through the ups and downs, when you have to sell to fund retirement. However, this also reduces your expected returns as well. I am not a fan of selling stock in order to live off in retirement. I would much rather live off the dividends, which are returns generated today, I could live off. Living off dividends gives me a return on investment today, which is known and easier to calculate and rely on. Hence, it is easy to know how much I can safely withdraw from my portfolio for living expenses, based on current market conditions. Not based on some historical backtest using information from periods that are no longer applicable.
I would argue that too much fixed income can actually be detrimental to retirees, especially as we are living longer, on average. In this case inflation and higher taxes on interest (vs. dividends and capital gains) mean that you are getting much less than expected and that stability is largely illusory. Of course, one could argue that fixed income could be helping people's ability to hold, and keep them invested. Not everyone has a high risk tolerance. But on the other hand, the most important thing is long-term stability and growth. The short-term swings up and down are largely noise. Getting too caught up in them could make one feel good in the short-run, but at the expense of the long-run.
I understand that from a behavioral perspective, it is easier to hold on to a portfolio that has some equity and some fixed income exposure. So perhaps reducing expected returns and suffering from inflation on those fixed income is the price to pay to endure the inevitable ups and downs in the markets and the economies. Not everyone can stick to a 100% equity allocation. However, it is good to think through assumptions, test our understanding of things, and write them down on paper, in order to try and learn, and decide for ourselves if we have some gaps that need to be overcome.
Note I have had this idea brewing on the back of my mind for many years. I do expect many to disagree, and that's fine. Not everyone has the risk tolerance to be 100% in equities. I also like that I am posting this article during turbulent time in the markets. It's braver, versus posting it when markets are at all-time-highs.
