We are often under the impression that when we invest in the stock market, we are taking risks. The media doesn’t miss an occasion to remind us how the stock market crashed in 2008 and makes also sure to “advertise” on their premium spots every time investments drop by 10%. Considering it happens all the time, we are fooled into perceiving that the stock market is a risky place to invest our money. It gets even worse when we are about to retire since we count on our nest egg live the life of our dreams.
But what if I tell you that a 100% dividend stock portfolio is a safe portfolio? Even for retirees?
Let’s Start With What We Call “Safe”
I’ve met many investors during my career and the perception of a safe investment can be summarized in 2 types:
- Bonds & Certificate of Deposits (CD’s)
- Real Estate
When you look at individual bonds or even at a bond ladder you can expect to barely beat inflation. A good bond ladder should help you beat inflation by 1% (averaging a 3-4% yield). However, the problem is that if you go with bonds, you will see your capital fluctuates over time (due to interest rate movements) and if you go with CDs, your money is frozen according to the maturity dates. Low yield, no flexibility and still a risk of losing money (if you want to withdraw your money before term). There is nothing here that convinces me that it’s “that safe”.
When you look at Real Estate, it’s even worse. Investors think it’s a safe place to put your money while you can definitely lose money. Further to this logic, most Real Estate investors tend to remember the price paid and the sale price and forget about everything in between (taxes, maintenance, mortgage interest, empty apartments, etc). When you factor everything in your yield calculation, you will notice that, once again, Real Estate beats inflation by 1 or 2 %. However the risk and the liquidity of your investment should be a concern.
As you can see, even the notion of “safe”, once analyzed, is not so safe when it comes down to investments. I guess each asset class has their pros and cons.
Now Let’s Look at Dividend Stocks
Now, when you look at the historical yield from stocks (regardless if they pay dividends or not), we find an investment return of 8-9%. While dividend stocks may have less growth during economic booms, they also go through smoother drops during a recession. One way or the other, they have a huge advantage; they distribute a part of their profits.
The dividend payout is what makes dividend stocks so “safe”. But it’s not only the fact that you receive a quarterly payout that makes them interesting. It’s the fact that these companies are so well established and are so strong that they are able to share their profits. If you build your portfolio with Dividend Aristocrats, Achievers or Champions, you will likely have a positive yield after 10 years. The best part is that you will also earn dividends in the meantime ;-).
What does “Safe” Mean?
If you are considering a safe investment, one that never show a negative yield, I have a little surprise for you. Some of these “safe” investments are pretty risky as they will offer an investment yield under the rate of inflation. Therefore, you are 100% certain to lose money while investing. How safe is that?
In order to consider if an investment is safe or not; I would consider the possibility of losing money over more than 10 years. If you don’t invest over a long period of time, then, just get a high interest savings account and forget about the rest. But if you are investing for your retirement, you should define the word “safe” with a larger spectrum. In fact, even if you are retired, you should have the same definition of “safe”. Why is that? Because you will most likely be retired for a good 25 years! So unless you have tons of money and just don’t care about how much you are making with it, I think that dividend stocks would be a great place to invest your money.
In my opinion, a “safe” investment is one that will not only protect your capital but will also protect your money against inflation over a 10, 15, 25 year period. And this is what dividend stocks do. You get paid to wait and can still expect good growth from the stock.
I think it’s silly to check your portfolio statement on a quarterly basis (let’s be honest, you check it at least once a week) and reshuffle the stocks in your head before your pull the trigger and decide to sell some stocks to buy more “interesting” ones. I think this is why most people lose money: because they can’t endure the pressure of losing money on paper. I think it’s important to have fundamental reasons to sell a stock, not just doing it due to a “technical” situation.
What’s your take? Do you think that a 100% dividend portfolio is a safe investment?
I cannot really comment on if I think a 100% dividend portfolio is a safe portfolio, because I have not started investing yet. (Other than RRSP’s) But by far, your arguments supporting dividends are the most clear, concise, and to me makes the most sense out of all other investing strategies.
As always, great article. Keep them coming!
The key is the “E” in the P/E ratio at this point. If earnings plummet, what does that do to multiples, and thus to either the price or dividends?
This is the key risk, I believe.
Sorry Mike I’ll have to disagree. Bonds have a role to play in one’s pf. They help in keeping volatility down.
Imagine if you were looking forward to enjoying your retirement at the beginning of 2000 with just stocks. Not saying good stocks won’t go up in the long run, but retirees are more concerned with the present and bonds provide a cushion.
Bonds used to be “safe”, even for corporates at one time, but the fiasco of “stimulating” economies and the blow to investor confidence with the Bell corporate bond holders have put paid to that idea. The government paper isn’t worth the paper it’s printed on these days. They are all trashing their fiat currencies to one end – devaluation to escape their excessive debt obligations.
I’ll take my chances on dividends, thanks. I own a lot of dividend paying stocks that run their businesses better than any bond issuing government does, producing stuff that the general public needs, like food, fuels, power, machinery, infrastructure and banking. Since 2000, my portfolios have quadrupled in value. If you had dividend payers pumping out cash during any downturn, unless you had to sell them, why would you especially when paying out higher rates than a government bond?
Government interference is the biggest risk to my portfolios. Hot shot Wall Street banksters are the other ones. Why would I buy their risky paper obligations, or sliced and diced debt obligations? They pay less than inflation, even if I believe their numbers. Inflation is a happy 6%, just keep an eye on gasoline and food prices, the two items excluded from CPI numbers that they use to lull you into a false sense of “what me worry?” on inflation.
Bonds are high risk now in my books. Their traditional role in a portfolio has been usurped when you factor in the potential future purchasing power risk on these investment instruments.
jt,
Well said, my brother. I believe bonds are EXTREMELY risky right now, when you factor in after-inflation real returns. You are going to be looking at negative returns in most cases. I wouldn’t invest in treasuries right now with my worst enemy’s money.
I’m about 95% in dividend growth stocks right now, with the other 5% acting as dry powder at any given time. These numbers fluctuate as I deploy capital. I think now is an extremely apparent time to be aware of one’s situation.
This is not to say I’ll never go long on bonds, but until interest rates rise significantly I’ll stay long on equities. When the rates eventually rise, bondholders will be getting killed. Even the ones who supposedly hold to maturity will still be getting killed as they’ll be collecting a fraction of the interest that everyone else will.
Thanks for the article Mike!
In the 1st sentence of the “now let’s talk about dividend stocks” you misuse the word “yield” when you should be using “return”, an important distinction for everyone to understand.
The mistake is again made in the second to last sentence in the second paragraph in the same section, when you say “you most likely will have a positive yield after 10years”. Never can a yield be negative. What you’re saying is that the yield itself (always a positive) when combined with (in that example) a negative share price return, can offset or minimalize the negative total return of poor price action of your stock.
Sorry to be nit picky, but now looking back on the article, this mistake is made numerous times and can confuse investors who may not understand the distinction.
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I agree with the premiss of this article. I believe that a portfolio exclusively made up of dividend stocks that you constantly monitor is safe, but that depends on one’s definition of safe. In my opinion, I’m looking for companies who I have safe expectations of their operating results. Meaning, in the following years I expect them to continue to raise their EPS by making more money, cutting costs, buying back shares when fairly valued, etc. If the company can do this and weather the storm of economic turmoil be it the financial or dot com bubbles extended periods of heavy inflation, etc., while maintaining their dividend culture, then to me that’s divine safety.
Before i purchase a stock, as I make a valuation of the company, price is essentially the most important determinant of whether it is a buy or not. Meaning, the company at that point in time is worth X to me. If the Price is less than X, it’s a buy. But, once i buy that “divine safety” company, the share price to me is essentially irrelevant. My educated guess is that if today the company is worth X and they continue to operate as I expect them to, the market will probably reward that productivity with a rational corresponding price at some point in the future. As long as they’re doing so and continuing to pay me for being an owner of their business, I don’t care if there are extended periods of irrational market price behavior. I can say that I’m ok with that period of irrationality extending past 10 years giving me a negative total return, as long as my ability to maintain a growing level of income is uninterrupted.
As to the “beat inflation” example mentioned in the first paragraph of the “What does ‘safe’ mean” section, I’d argue that a current investment’s yield that is below the current rate of inflation CAN beat inflation if it’s growth of the yield is greater than the current rate+growth in rate of inflation. But again, we’re talking about yield and not return.
An investment in a security with a yield higher than inflation can outpace inflation so long as the extra is reinvested into the portfolio. If the excess is not, you’re only staying level with inflation.
Most investors are going to want some measure of safety out of the income portion of their portfolios. I think that dividend stocks could fulfill that function.
I wouldn’t exactly call a dividend portfolio safe. Just like all other stocks, they can be hit pretty hard when the market turns south, which will wipe out whatever earnings you may have had from dividends.
“There is no such thing as a safe asset, only a safe price.”
I think bonds always have place in one’s portfolio Mike.
Bonds are parachutes when equities are tanking.
That said, a bunch, and I mean 20+ basket of blue-chip dividend-paying stocks is about as safe as you can get for equities, unless you are indexing of course.
If you get about 30-40 stocks in your portfolio, always paying dividends and have done so for decades or generations, you’re almost indexing. I hope to be in this position in another 5 years.
Further to my previous post: I don’t discount bonds returning to a position in my portfolios when some sanity to markets returns and that will only happen when financially sane governments return. Are you a betting man? Bonds are not close to compensating us for that risk.
However, as retail investors we are at the level of plankton in the vast world of the bond markets. Believe me on that. Not many of us have the kind of coin to win against the “house” on fees at your local brokerage to build an effective, well run bond ladder. Besides that, your selection available is hugely limited.
Even if you subscribe to the age rule, I’m 60 so I should have 60% of my portfolio in bonds, how good a return do you think you’ll get? Well, even if my portfolio was say worth $1 million, an not unrealizable value for someone my age, $600,000 in bond holdings in the bond market is still “plankton” when compared to the size and value of bond trades daily. We’re talking trillions. So, how good a deal on bond selection do you think you’re going to get on a ladder of individual bonds at $10,000 per pop? The house holds all the cards on a bond trade for the amounts you can trade. I used to work for a house.
ETF’s are the only way, but you have to trust the manager that your best interests are at heart when he/she trades that account. OK, it’s better than nothing, but for me corporates only, as sovereign debt is toxic and well even some of that corporate stuff is wallpaper too, as well as their stock. Owning that ETF, you have no control on what or who they buy. If that ETF is tanking on some bad stuff, who’s gonna buy it from ya?
For the risks attached to some of that bond market out there now, I think we should be getting higher rates than they are today to even think of buying any of it, especially sovereign debt.
Like Dividend Mantra, I’m holding 95% dividend growth stocks in my portfolio. I have a defined benefit plan, which I consider to be my bond component. Even my mom, who’s nearing retirement, holds a large percentage of dividend stocks.
The problem with worrying about a market crash when you retire is that you’re not going to be selling your entire portfolio the day you turn 65. Your withdrawal rate may be higher in the first few years (unless you’re just withdrawing dividends), but if you stay invested it will balance out again when the market rebounds.
I actually think that if you are looking for a parachute, you might as well not invest that money period ;-).
If you look at the value of your portfolio during a crisis, you will hope to get bonds. But if you look at your portfolio 10 years from now, you will be greatly disappointed to see how much you have left on the table holding bonds.
Volatility is not risk. there is a huge difference between the 2. Example: do you think that National Bank (NA) really worth $25 back in December 2008? Do you really think that it was a risk assessment or due to volatility? 6 months later, the stock was back up to $60 or so. Nothing was different in NA financial statements. It was just the volatility that disappeared.
I never liked bonds anyway 😉 hahaha!
I am investing for my retirement and since I am in my forties, I have had a 100% weighting in a diversied basket of dividend paying Canadian and US common stocks. I also use dividend reinvestment plans for all holdings. I have had this basic portfolio construction for 10 years and do not plan on changing anytime soon.
Keep in mind that people most interested in “safe” investments are the elderly. Such people don’t have the luxury of being able to focus on only 10-year or longer timeframes. Prior to the financial meltdown, dividend stocks were commonly believed to be safe. Given that dividend mutual funds and ETFs had disproportionately large holdings of financial stocks, they took a disproportionately hard beating in the crash. People who thought they were being safe got burned.
The crux of my message is that you should never overlook concentrations in any particular industry segment or asset class. Risk can build in a segment or class over time (witness the run-up in tech stocks in the 1990s and the business risk build-up in the financials attributable to the housing bubble) and one can become complacent by virtue of the fact that recent returns have been good and nothing bad has happened yet.
Remember the parable of the turkey. The turkey feels more loved and secure every day that the farmer shows up and feeds him, right up until the day before Thanksgiving. Past experience is no idicator of future experience. Stay on your toes and be careful of broad assumptions; e.g., dividend stocks are safe.
I definitely agree. Ive only had divvy stocks in all my accts, Lif, taxable and our TFSAs. I hold some bonds but only in a closed-end bond fund paying around 11.5% as a dividend. Buffett said what Ive been thinking for a while. They are dangerous. I believe if you want something Safe,then buy our banks. Nothing safer and they raise their dividend regularly and you will likely get some capital gain eventually. No bonds do that.
I am invested only in stocks, the vast majority being dividend paying stocks. I have lived off dividends since 1999, so I have been through two bear markets since I stopped working. Yes, the value of my stocks has been quite volatile at times, but the dividend income has always increased.
My5 year median increase is 11.35%, with 5.29% in 2010 and 23.21% in 2007 being my lowest and highest increases. I have stocks with different patterns of dividend yield and dividend growth.
I would consider that I am generally a conservative investor.
Also, we have had a bull market in bonds for at least 20 years. At some point interest rates will go up and we will start a bear market in bonds.