Investors spend their wholes lives accumulating a nest egg through saving and investing. At some point however, retirees need to figure out a way to pensionize their nest egg and ensure that it generates a sufficient stream of income.
The first source of income in retirement for many retirees is going to be Social Security. Another source of income could be derived from an employer pension plan. Generating income from a nest egg however sounds trickier than it actually should be. This is because of the multitude of options, different types of investment products and types of accounts.
In reality things should be simple. Investors simply need to invest their funds in assets that generate a rising stream of income, which also preserve their values over time. One asset type that fits this criterion include dividend growth stocks. These stocks are the misunderstood by many, which is why I see them as the best kept secret on Wall Street.
Dividend growth stocks are companies which have managed to increase their distributions to shareholders for a prolonged period of time, typically over a decade. This ensures that the dividend income at least keeps up with inflation. In order to achieve this in a sustainable fashion however, dividend growth companies need to be able to grow earnings at a decent rate. This ensures that the dividend payment is sustainable and lessens the risk that retirees would endure a dividend cut that could jeopardize their retirement income. Rising earnings should make the business that investors hold stock in more valuable, which should result in rising stock prices. This should help investors maintain the purchasing power of their principal over time.
In a previous article I have included the entry criteria I use to screen potential dividend candidates from such elite lists as dividend achievers and the dividend champions lists. I ran my screen and came up with a sample of the following tried dividend growth stocks:
Johnson & Johnson (NYSE:JNJ), together with its subsidiaries, engages in the research and development, manufacture, and sale of various products in the health care field worldwide. This dividend aristocrat has consistently raised distributions for 50 years. Over the past decade the company has achieved an average dividend growth rate of 12.40% per year. The stock is currently attractively priced at 14.70 times earnings and yields 3.50%. (analysis)
McDonald’s (NYSE:MCD), together with its subsidiaries, franchises and operates McDonalds restaurants primarily in the United States, Europe, the Asia Pacific, the Middle East, and Africa. This dividend aristocrat has consistently raised distributions for 35 years. Over the past decade the company has achieved an average dividend growth rate of 27.40% per year. The stock is currently attractively priced at 17.20 times earnings and yields 3.30%. (analysis)
Aflac (NYSE:AFL), through its subsidiary, American Family Life Assurance Company of Columbus, provides supplemental health and life insurance. This dividend aristocrat has consistently raised distributions for 29 years. Over the past decade the company has achieved an average dividend growth rate of 20.40% per year. The stock is currently attractively priced at 8.70 times earnings and yields 2.80%. (analysis)
United Technologies (NYSE:UTX) provides technology products and services to the building systems and aerospace industries worldwide. This dividend achiever has consistently raised distributions for 19 years. Over the past decade the company has achieved an average dividend growth rate of 15.30% per year. The stock is currently attractively priced at 16.40 times earnings and yields 2.70%. (analysis)
Chevron (NYSE:CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. This dividend champion has consistently raised distributions for 25 years. Over the past decade the company has achieved an average dividend growth rate of 8.80% per year. The stock is currently attractively priced at 8.70 times earnings and yields 3.10%. (analysis)
On a side note, dividend investors should try to create a diversified portfolio consisting of at least 30 individual securities and try to have representation from as many sectors as possible. Investors should also avoid chasing yield by purchasing shares in companies which have unsustainable payout ratios.
By living solely on the income generated by their investments, retirees would avoid depleting their capital base by selling off the very same assets that should support them during their retirement. Selling off shares that you own, and relying exclusively on capital gains to provide for you during retirement is akin to cutting off the branch you are sitting on.
When the pot of gold is spent, the music will stop and the party will be over. That is why relying only on the dividends generate by your portfolio, is a smart way to generate income in retirement that grows over time and maintains purchasing power of income and principal.
Full Disclosure: Long JNJ, MCD, AFL, UTX, CVX