I live in a bedroom community of Pittsburgh and there are two primary routes to get to the grocery store. Back roads and the highway. During perfect conditions, the backroads take about twelve minutes and the highway takes about nine or ten minutes. I always take the backroads and my wife would choose the highway most of the time.
My logic is that in virtually all conditions, the backroads take 12 minutes. The highway, while faster during optimal times, could take up to 30 minutes at other times, sometimes without warning or expectation. My perspective is, “Why take the chance just to potentially save a couple minutes?” (Additionally, in my favor, this argument totally ignores the beauty and peacefulness of each trip which 10 times out of 10 would go to the backroads.)
Rory Sutherland, author of the fantastic book “Alchemy“, might refer to my decision framework as the “best-worst-case scenario.” I immediately loved that phrase because I can relate to it. An example as to how this might work for retirement: I don’t come across too many retirees looking for the portfolio that will provide the highest possible return as they are generally more interested in a portfolio that will get them through retirement with the fewest bumps possible. In other words, the “best-worst-case scenario.”
In a 30-year retirement, you will likely experience good markets, bad markets and markets that seemingly don’t go anywhere for years on end. We have no idea what the timing of these markets will be, just that you are likely to experience all of them at some point.
Where we stand right now, there seems to be some sort of consensus amongst everyday investors and pundits that forward-looking returns are likely to be lower than the long-term average. These arguments make sense. I think we can at least agree that returns are likely to be lower than we’ve experienced over the last ten years.
A quick detour: For the record, I’m not necessarily convinced of returns being lower than the average as Price/Earnings ratios aren’t too out of line according to JP Morgan’s Guide to the Markets.
25-Year Average: 16.22
That doesn’t scream excessive to me, but I digress.
While I’m not necessarily convinced, I should note that I am not a prognosticator of the markets and therefore take no stance whatsoever. My only goal is for clients to be prepared for all possibilities. Detour complete.
Let’s say that the consensus is correct and forward-looking returns are lower. This would mean we are in store for either a bear market or a flat market. If that’s the case, what should a retiree consider doing with their portfolio? And how can those decisions address what is top of mind for every retiree – cash-flow?
Retirees need a portfolio that produces ever-increasing cash-flows. I think we can all agree that it’s hard to live the retirement you’ve dreamed of without some level of confidence that your cash-flow needs are going to be met. And these needs must be met through all market environments. Let’s explore three market possibilities.
Bull markets, which I’ll define as markets that perform roughly in line with historical norms, are highlighted by a relatively smooth long-term trendline up albeit with occasional volatility.
In this case, assuming a reasonable portfolio withdrawal percentage and asset allocation, I think most any good strategy will get you across the finish line. But retiring into bull markets doesn’t cause too much angst for the average retiree, so I won’t spend any more time here.
I’ll define bear markets as markets where the ‘price’ is declining at a rapid pace over any period of time, including a 20% or more drop in price. These may be the most harrowing of all emotionally, but perhaps not as bad for long-term fiscal health as the flat markets discussed below.
The beauty of consistent dividend payments is this – nothing changes when everything changes. Intraday, quarterly and annual returns don’t mean a whole lot. Even annual returns can be volatile as evidenced by the graphic below:
As the market fluctuates around the trendline, it’s not surprising to know that some companies are more volatile than others. But interestingly, dividend growers and initiators are a little different.
As you can see from the graphics above and below, dividend growers and initiators are the least volatile of the bunch. While I do find it interesting that the dividend growers and initiators provided the best return over the period (investors could have their cake and eat it too) I would, nonetheless, recommend that you ignore the returns data because if you go into this with the expectation of outperformance, you may be disappointed. The focus is and should be, income, not the highest return.
In retirement, in general, retirees are seeking one thing: continued consistent income throughout their retirement through all market environments. With dividend growth investing, it can often provide much-needed income and less overall market volatility – something retirees also seek.
In flat and bear markets, when it comes to dividends, it’s important to remember one thing: The number of shares you own matters, not necessarily the price of those shares. Dividends are paid on a per-share basis, so the more shares you own, the higher the dividend stream.
Instead of worrying about the balance of your account, it’s better to focus on how much income is spinning out of the portfolio.
There have been two real periods of flat markets in the post war era – so a small sample size – but it’s interesting to look at them to provide some context. Below are two graphs – one is the 1970s and the other is the 2000s. Both were pretty much flat decades from a price return perspective.
Chart Below S&P Price Return 1970-1979
Chart Below: S&P Price Return 2000-2009
These two charts show only the price return of the S&P 500 so I can highlight the importance of dividends below. If these charts are alarming, it could have been even worse if you were utilizing a pure growth strategy (i.e. tech-heavy, non-dividend paying stocks) as many investors were thanks to the tech-crazed run-up during the late 90s. But looking at the S&P, the dividend of the S&P did provide a buoy of sorts during these two flat periods.
During the 1970s, the dividend payout of the S&P made up 73% of the total return. And during the 2000s, a time when the total return of the S&P was actually negative, the dividend provided much-needed cash flow for investors.
Think about it like this…In all stock market environments, but most importantly during flat markets and bad markets, the dividend is the ONLY way you can generate income from your equity investment without having to reduce your percentage ownership in the business. Said differently, if you own a stock that does not pay a dividend, your only source of return is price appreciation.
That can be a tough pill to swallow when the markets aren’t cooperating with your retirement projections. If you are trying to take income from your investments without dividends being a significant portion of those withdrawals, you are forcing yourself to reduce your ownership stake in these companies, sometimes at inopportune times.
And if the pundits are correct and we experience lower than average market returns, which approach would seem more stressful to you? Living on dividend-based cash-flow produced by your investment portfolio or having to select which investments to sell to generate cash-flow for your retirement?
Would it be wise to continue to get paid to own these companies via dividends while we wait for an economic recovery? It’s a nice feature that while the investors around you are capitulating, each dividend check you receive is providing a real tangible benefit from your portfolio without you having to do a thing.
All of this is not to say that dividend growth investing is for everyone, because it certainly isn’t. There are many investment strategies that can work and plenty of people I respect in our industry do it differently. But when I consider how a dividend growth strategy can potentially sustain an investor through retirement and can help keep their eyes on what matters most – cash-flow – I think it has the potential to provide the best-worst case scenario for the modern retiree.**
As racing legend Mario Andretti was rumored to tell his son, “Win the race as slowly as you can.”
**It’s also important to note that this equity strategy should be paired with a fixed income strategy to allow for additional income if needed in extended bear markets and other potential scenarios.
This post is not advice. Please see additional disclaimers.
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I am a Financial Advisor in Pittsburgh and a CERTIFIED FINANCIAL PLANNER™ professional with Shorebridge Wealth Management. I enjoy helping clients and readers find sensible answers to retirement’s big questions. If I can answer any questions for you, feel free to Contact Me or if you think you might be a fit for our practice, see Who We Serve.