I have an obsession with dividend stocks. I log-on to my brokerage accounts every morning, in order to check the amount, timing and source of any dividends deposited. On certain days, such as the 15th of some months, the amount of dividends received is much higher than my salary. To me dividends represent financial freedom from a 9 to 5 (or typically later) job.
Dividends are an integral part of my retirement strategy. The point at which I will be able to retire will be when distributions exceed my monthly expenses by a sufficient margin of safety at the crossover point. I do not blindly invest in dividend stocks however. I follow a multi-step process, in order to ensure that unnecessary risks are not taken along the way.
A long time ago, employees used to slave away for 3 – 4 decades, until they received the golden watch at their retirement party. Typically starting at the age of 55, retirees were able to draw upon their company’s defined benefit plan. A few years later, they were able to receive Social Security checks, and live comfortably for the rest of their lives. A few decades ago however, corporations started cutting retirement benefits, instead offering optional defined contributions plans, such as 401K’s.
There is much speculation that the age for receiving social security benefits will be increased going forward, and that the amount of the benefit might be reduced in the meantime. This means that employees should be relying on themselves for funding of their needs in retirement.
Many retirees are typically sold on traditional asset drawdown schemes such as the four percent rule. This rule was popularized by CFP William Bengen in his research studies. According to this strategy, investors would purchase bond and stock index funds, allocate them in their portfolios according to their risk preferences. Investors will then sell a portion of their portfolios each year, in order to pay for their lifestyle, while rebalancing their portfolios and paying their financial planners and mutual fund managers sizeable fees in the process.
The issue with this strategy comes when retirees are experiencing prolonged flat or bear markets. People who retired in 1999 – 2000 or in 2007 have been selling off portions of their portfolios, while the investments in their portfolios have remained flat or declined in value. If the market keeps being flat for another decade, these people will certainly run out of money and enjoy a much lower standard of living in the process. To me, selling off a portion of my assets each year is akin to cutting the tree branch you are sitting on.
This is one of the primary reasons why I am sticking to a strategy, where my portfolio throws off a decent amount of cash every month, quarter or year. This way, I maintain ownership in the companies I hold, without risking selling stocks for income during flat or bear markets. No matter what the markets do, as long as I have selected fundamentally strong companies, my dividend checks will keep coming in the mail.
In order to ensure that my portfolio will generate a rising stream of dividends every year during my planned retirement, I need to follow several sound principles around diversification, entry criteria and stock analysis.