The goal of an early retiree is to have the flexibility to do what they want, paid for by their nest eggs.
Dividend growth stocks should be an ideal strategy for these individuals, because they provide a relatively safe stream of income which is always positive and is more stable than relying on total returns. The risk with traditional approaches to retirement such as the 4% rule is that you might have to sell assets when prices are low or stagnant, which could deplete the nest egg that you worked so hard to accumulate.
With dividend investing, you are essentially living off the dividends generated by the portfolio. This is similar to living off the fruit from a tree you have planted twenty years ago. Selling chunks of your portfolio in order to finance expenses in retirement is similar to cutting the tree branch you are sitting on. By cutting off the tree that gives you fruit, you won’t get any more fruit. However, by focusing on the fruit (income), you not only receive more fruit over time, but you also can benefit from long-term appreciation in the companies you have invested in ( the tree grows too). It is a true win-win for long term dividend investors. I also believe that dividend growth investing addresses many risks that retirees face these days.
Some of the risks that retirees face is longevity risk, inflation risk, and investment risk.
To put it in simple words, longevity risk is the risk that you would run out of money in retirement. This is why it is so important to only live off the income generated from your portfolio, and avoid selling the assets that generate it, in order to pay for expenses. A portfolio that generates enough income for you, would also reduce complexity in trying to live off the pile of capital you accumulated during your working years. You won’t have to suffer through the complexity of figuring out optimal percentages of your portfolio that need to be sold in order for you to live in retirement. Dividends are a more straightforward approach, where you invest your cash in companies that distribute a portion of profits every 90 days to you, and then you live off that cash. In order to reduce the chances that income will decrease and hurt your chances of staying retired, you need to diversify, build portfolio slowly over time, and focus on companies that have catalysts for growth by purchasing them at attractive prices. The goal is for this dividend machine to pay you a growing stream of income for decades, therefore keeping your retired status.
Inflation risk is the risk that your income in retirement will not increase as fast as inflation, and therefore it would lose purchasing power over time. Over time, the US economy has experienced annual inflation of about 3%. While a 3% decrease in purchasing power might not be felt over a couple years, over a 24 year period it would result in doubling of price level ( or decrease of your purchasing power by 50% in 24 years) For example, if your portfolio generates $30,000 in annual dividend income that grows at 6% per year, your income will maintain purchasing power as long as inflation is below 6%. Therefore, a 3% annual inflation rate would actually leave some margin of safety in dividend growth income. Historically, dividends have increased a couple percent above the rate of inflation, driven by growth in earnings. Therefore,by relying on dividend growth stocks, an early retiree should be able to mitigate inflation risk successfully.
Investment risk is the risk that your investments will not work out as well as expected. If investments do not succeed, you might have to go back to work. This is a scenario that you will try to avoid as much as possible. In order to achieve that, you need to slowly build a diversified income portfolio that consists of at least 30 - 40 carefully chosen companies that have a proven track record of dividend increases. You need to focus on those companies that have the durable competitive advantages that would allow them to still be in business 20 – 30 years from now. The securities you purchase should be representative of as many sectors as possible. It is no surprise that a typical dividend portfolio holds consumer staples such as Coca-Cola (KO), Clorox (CLX) and Colgate-Palmolive (CL) to name a few. These are companies that provide essential products or services to consumers, who are loyal to their brands and purchase products repeatedly. In your analysis, you should also focus on catalysts that would allow for growth in earnings and dividends over time.
Another very important thing to look for is entry price. Investors should avoid overpaying for dividend stocks, because this reduces their margin of safety, and could result in lower returns, even if the company they picked generates record profits in the decade after it was purchased. Investors also need to focus on companies that can afford paying their distributions, and to repeat it one more time focus on companies that can grow dividends. A nice starting list is the file of dividend champions, that Dave Fish updates every month on his site DripInvesting.
So if I were starting a portfolio from scratch today, which companies would I be looking to buy over the next year? I have listed a few companies, which I believe are good values today, and offer decent growth in earnings and dividends in the future. Using a broker like Motif Investing, all 30 could be purchased for a one time fee of $9.95. Of course, this is just a snapshot in time - if you asked me 6 months ago, I would have told you something else. If you ask me 1 year from now, the list might change.
Ticker
|
Name
|
Years Increase
|
Industry
|
Yield
|
P/E EST CURR YR
|
ACE
|
ACE Limited
|
23
|
Insurance
|
2.63%
|
11.46
|
ACN
|
Accenture
|
11
|
Financial Services
|
2.21%
|
20.26
|
AFL
|
AFLAC Inc.
|
32
|
Insurance
|
2.82%
|
9.56
|
AMP
|
Ameriprise Financial Inc.
|
11
|
Financial Services
|
2.33%
|
12.89
|
DEO
|
Diageo plc
|
5
|
Beverages-Alcoholic
|
3.37%
|
17.5
|
ETN
|
Eaton Corp. plc
|
6
|
Machinery
|
4.06%
|
11.79
|
GIS
|
General Mills
|
12
|
Food Processing
|
3.10%
|
28.37
|
GPC
|
Genuine Parts Co.
|
59
|
Auto Parts
|
2.99%
|
17.47
|
GWW
|
W.W. Grainger Inc.
|
44
|
Electronics-Wholesale
|
2.11%
|
18.53
|
HCP
|
HCP Inc.
|
30
|
REIT-Health Care
|
6.09%
|
N/A
|
HSY
|
Hershey Company
|
5
|
Confectioners
|
2.57%
|
21.80
|
IBM
|
IBM
|
20
|
Technology-Hardware
|
3.41%
|
12.91
|
JNJ
|
Johnson & Johnson
|
53
|
Drugs/Consumer Prod.
|
3.20%
|
16.76
|
KMI
|
Kinder Morgan
|
5
|
Oil&Gas Services
|
6.21%
|
N/A
|
LMT
|
Lockheed Martin
|
12
|
Aerospace/Defense
|
2.93%
|
17.95
|
MMM
|
3M Company
|
57
|
Conglomerate
|
2.86%
|
18.63
|
MO
|
Altria Group Inc.
|
45
|
Tobacco
|
4.01%
|
20.58
|
O
|
Realty Income
|
22
|
REIT-Retail Stores
|
5.04%
|
N/A
|
OHI
|
Omega Healthcare Investors
|
13
|
REIT-Health Care
|
6.40%
|
N/A
|
PEP
|
PepsiCo Inc.
|
43
|
Beverages/Snack Food
|
3.10%
|
20.60
|
TROW
|
T. Rowe Price Group
|
29
|
Financial Services
|
2.81%
|
15.1
|
UL
|
Unilever
|
19
|
Consumer Products
|
3.37%
|
20.51
|
UNH
|
UnitedHealth Group Inc.
|
6
|
Health Care Services
|
1.48%
|
18.05
|
UNP
|
Union Pacific
|
9
|
Railroad
|
2.61%
|
14.36
|
UTX
|
United Technologies
|
22
|
Conglomerate
|
2.83%
|
13.13
|
VZ
|
Verizon Communications
|
10
|
Telecommunications
|
5.06%
|
18.81
|
WFC
|
Wells Fargo & Co.
|
5
|
Banking
|
2.90%
|
12.73
|
WPC
|
W.P. Carey Inc.
|
18
|
REIT-Prop. Mgmt.
|
6.72%
|
N/A
|
WMT
|
Wal-Mart Stores Inc.
|
42
|
Retail-Discount
|
3.09%
|
13.53
|
XOM
|
ExxonMobil Corp.
|
33
|
Oil & Gas
|
4.13%
|
12.9
|
Some investors are not excited about dividends yields in the 2.50% - 3% range today. That is because they lack the vision and patience of being long-term share owners in a business. A company that yields 3% today, but can grow earnings and dividends in a way that it could double them every 7 – 10 years would generate a lot in future dividends to the shareholder. In fact, the reason to purchase dividend growth stocks is that you would receive very high yields on cost in the future, without having to reinvest any new capital. When purchasing an investment, it pays to take a long-term view on it, in order for the power of compounding to take care of you.
Of course, this list is not a recommendation for you to buy. It is a list of companies I will buy if I were starting out. I also know to monitor my positions, and dispose of dividend cutters immediately.
Full Disclosure:
Relevant Articles:
- Dividend Companies I purchased in August
- Dividend Stocks Provide Protection in Any Market
- Create your own dividend ETF with Motif Investing
- How to value dividend stocks
- How to become a successful dividend investor