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Stress Testing Your Dividend Portfolio For Safety

Keep an eye on the entire portfolio to ensure long term viability

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I have long been ridiculed for my ideas that retired investors should have at least a 25% exposure to fixed income – US Treasuries or Agency Bonds being the safest fixed income. The truth is that investors who plan on relying on their portfolios for income in retirement should have exposure to assets which have different economics. Stocks and Rental Real Estate should do well during moderate inflation and during periods of economic growths. They are also going to maintain some purchasing power during high inflation.

Bonds on the other hand would maintain their income stream during severe recessions, depressions and deflations. While 10 year US Treasury Bonds yield less than 2% today, there were several times over the past two years when they yielded close to 4%. Currently, 30 year Treasury Bonds yields 2.70%, but they used to yield close to 5% on several occasions over the past few years.

The key to accumulating fixed income is purchasing a set amount every month or so. I plan on using the dividends from my stock portfolio for 5 years before my retirement date to purchase fixed income. While current yields look low, they could still go lower or remain low for extended periods of time. The yields on long-term Japanese Government bonds have been declining for years, as have the yields on US Bonds.

Two years ago, Roger Nusbaum ridiculed my article on Four Percent Rule for Dividend Investors in Retirement by claiming that bond yields were low and could only go up. Little did he understand that bonds play in important role that diversifies a retiree’s portfolio and passive income stream against unforeseen events. To Japanese savers in the late 1990s, a 10 year bond yielding 2% might not have sounded like much. Fast forward to 2011, and it is hard to even obtain that yield in a 10 year JGB.

Last, one of the final rules I have is to immediately sell a stock after it cuts or eliminated dividends. This would have had investors sell Citigroup in early 2008, Bank of America and Lehman Brothers (PINK:LEHMQ) before the bankruptcy. This rule ensures that I get out of a position with negative income characteristics that could wipe out a portion of my capital. It also ensures that I sell a company which I like, even if the fundamentals have deteriorated over the years.

Eastman Kodak (PINK:EKDKQ) paid dividends for many decades, but when the company cut distributions in 2002 at the time that the stock traded at $30 per share. This was 9 years before the company filed for Chapter 11.

Full Disclosure: Long JNJ, WMT, EPD, CVX

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