A little while ago, I wrote an article on the key metrics for a dividend growth investor. This lengthy article was about each metric I personally use to manage my portfolio and create successful portfolio models at Dividend Stocks Rocks. Following on this article, many readers commented with their thoughts. A topic that was recurrent was that I focus more on the growth aspect of my portfolio (both portfolio value increases and dividend payment increase). On the other side, I am also more open to invest in a low dividend yield stock (read 1-2%) and tend to ignore companies paying around 5% dividend yield.
Most investors agree with my strategy as long as they consider I’m relatively young and that I have plenty of time to let my portfolio yield grow over a long period of time. Retirees often argued that low dividend yield companies weren’t paying enough to support their retirement income needs. However, I respectfully disagree with their strategy of picking high dividend yield to support their income. As I’ve clearly demonstrated in this article about low yield vs high yield, there is a huge risk of seeing your high dividend yield stocks collapse during a recession. But one of my reader got me digging even further. Ron replied that we could find solid companies with higher dividend yield. I will disclose the result of my research in a further article. For now, I wanted to look at another interesting factor for retirees: how much they get in their pockets. This is how I got to run a few hypothesis and work on calculations.
My hypothesis
Let’s assume you retire at the age of 65. On average, you will live another 20 years. For the sake of calculation, you have cumulated $1,000,000 for your retirement. In scenario #1, you will invest this money in a dividend growth portfolio paying 3% on average with a dividend growth of 6%. In scenario #2, you will invest the money in a high dividend yield portfolio with an average yield of 5% and a dividend growth of 0%. On the first year, the portfolio #1 generates $30,000 in income and portfolio #2 generates $50,000. Interesting enough, portfolio #1 will need 19 years to generate the same income as portfolio #2:
Source: author’s graph
In the light of this graph, it seems retirees would be better off with a high dividend yield portfolio generating 5% than a dividend growth portfolio. Plus, I must admit I wasn’t very generous with my second portfolio by granting it a 0% dividend growth rate. In the real world, chances are this portfolio would still show some growth over a long period of time. If I only gave a 1% dividend growth rate to portfolio #2, the majority of high yield investors would never be beaten by portfolio #1.
Source: author’s graph
Further considerations
In the light of those calculations, it seems that income seeking investors that have less than 20 years in front of us are better off choosing high yielding stocks to build their portfolio. To be honest, I was a bit surprised by this conclusion. But if you stop your analysis with pure numbers geared toward to income generation, this is a correct assessment.
However, I think further consideration must be made. First, unless you wish to leave all your savings to your heirs, you can also withdraw money from your nest egg on top of cashing your dividend payment. The ideal scenario would be that you generate a lot more than what you need solely through dividend payment, but this is rarely the case. Second, when a company pays a higher yield, it is usually because it is seen that this investment involves additional risks. Therefore, your investment return might be mediocre. This is actually what I demonstrated previously with this article. Finally, inflation could play a very important factor for retirees. If you have built a high yielding portfolio with limited growth, chances are inflation will eat your buying power slowly but surely. A portfolio showing an average dividend growth of 6% will never actually generate a growing buying power over time.
Conclusion
What I like about investing is there is never one and single truth. While writing this article, I realized it wasn’t the end of the world to pick high dividend yield to finance one’s retirement income. I still prefer the dividend growth approach, but I can see how bigger dividend payments could appeal a specific categories of investors. However, as you will see in my next article about this topic, finding those strong high dividend yield companies is far from being easy!
In Canada, a dividend portfolio dominated by Big Banks and Telecoms would likely surpass either of your portfolios discussed for total return and income. The major risk of a Bank and Telecom centric portfolio is its lack of diversification.
CJL,
The risk of being concentrated in only 2 sectors is very high. Imagine if Verizon would have entered the Telecom market a few years ago. Only the thought of it made the Telecoms drop like a rock.
Same thing for Canadian Banks, so far, they have avoided a Canadian housing bubble burst, but I hardly see how they will show important growth in the upcoming 10 years.
It was a good move to own banks in the past, it doesn’t mean it will in the future.
Cheers,
Mike.
As CJL mentioned, it is little hard to diversify our portfolio with Canadian stocks, unless if you are OK to build assets with 5 big Canadian banks.
I’m looking to move assets to U.S, but current exchange rate is not in my favor.
Hello FJ,
I know the currency factor may seems important for Canadians at the moment, but in fact, it plays a very small role over the long haul. Think about it, in 30 years from now, chances are the currency rate will change 20% at best in your favor or 20% against you. In both cases, 20% over 30 years is probably around 0.60% annualized rate. It’s cheaper than a mutual fund MER ;-).
Your examples are too black and white. It is quite feasible to construct a successful high dividend yield (5%+) portfolio which also generates dividend growth.
Case in point…I did some sorting with the latest Canadian Dividend All Star List (Aug. 2016). The list is comprised of Canadian companies that have increased their dividend for 5 or more calendar years in a row. Firstly, I sorted the list by high yield to low yield. I then eliminated all entrants with yields below 3.50%. Forty-two stocks remained. Their average numbers included:
Yield: 5.07%
Streak: 9.3 years
1-Yr DGR: 8.9%
3-Yr DGR: 9.6%
5-Yr DGR 12.4%
10-Yr DGR: 10.7%
Of course it’s understood that current data doesn’t dictate future results and that higher yield is likely higher risk but, hey, there is strength in numbers…these are 42 stocks after all. Should any fail the overall affect would be minimal. Losers can be replaced.
I personally have a high yield DGI portfolio (25 Cdn stocks, 10 US stocks) with a current yield ~ 4.8%. My annualized DGR over the past 8 years is 8.8%. Over the past 2 years it’s climbed to 13.9% due to exponential compounding of the dividends. I haven’t added in any new money since retiring in 2011 but I haven’t withdrawn any yet either.
Hello Bernie,
This is a very interesting comment. There are a few companies paying a high yield in the canadian market. Unfortunately, i’m pretty sure you have roughly 10 financials and the 4 telecoms. Therefore, you have a third of the group concentrated in 2 sectors. This make a risky portfolio don’t you think?
Cheers,
Mike
Mike,
The 42 high yield (>3.5%) Canadian companies which have been raising their dividends for 5 or more years in a row are comprised of:
12 Financials
7 Energy
6 Utilities
4 Telecoms
4 Basic Materials
3 Industrials
3 Real Estate
2 Technology
1 Consumer Cyclical
“This make a risky portfolio don’t you think?”
This is dependent on how you define risk. The only risk I’m concerned with is risk of dividend cuts. I’ve had a handful since I started with DGI in mid 2008, including two during the great recession of 2008-09. I consider my portfolio low risk overall. I have what I consider good sector diversity and a low overall beta of 0.51.
Good quick analysis that confirms my findings.
I have a blend dividend yield portfolio – quarter of monthly paying Canadian high yields, more than a quarter of US Blue Chip dividend yields, lots of Canadian Banks and Telecoms, rounded off with Canadian utility/pipeline/oil dividend stocks. It took me sometime to transition to my now 16 Canadian and 5 US stocks portfolio to “all-dividend” portfolio, while minimizing capital gains. I had more US stocks 3 years ago so I benefitted from higher US market returns except last year when US market return was anemic somewhat like this year so far. As someone who is not working (early retirement-I am hoping), I studied the didvdiend high yield vs growth thesis lately and concluded that dividend (in lieu of employment) income in hands is better but still needed some partial growth for inflation catch up. Hence for me a blend dividend yield portfolio is a better way to go.
The risk with my portfolio is with the TSX financial stocks so my next adjustment will be swaping some financials to surprisingly growing Canadian utilities. I am less concerned with Telcom stocks from dividend perspective as they are government regulated with self adjustments built-in. I have owned Telus for many years through DRIP and the dividend was cut only once during this time then recovered well after.
Do you have any thoughts on TSX utilities ( I own FTS, RNW, TRP) in lieu of big banks or insurance companies?
Hello Charlie,
thank you for your comment. I think you can’t really compare banks to utilities in Canada. The big 5 are playing in a separate playground protected by laws. They can’t virtually go wrong for a while. The worst that can happen to them is to see their stock price stagnate for a while. Still, the dividend will continued to be paid. In the utility world, I prefer EMA but I think FTS is a good pick too :-).
Cheers,
Mike
I agree that inflation is an important consideration in higher growth versus low growth discussions. Perhaps a minimum yield of 3% (50+ year historic inflation average) should be a minimum requirement for low growth-higher yield investors.
However, I get a little nervous when the “Dividend Guy” starts to address total returns as an important consideration in dividend investment selection. Sounds a little too much like the majority of the investment community and smacks of less concern about current returns. Also adds layers of investment timing and monitoring requirements not necessarily easy for the non-professional or more casual investor, particularly those interested primarily in income. What does the “buy and never sell” dividend crowd think about dividend AND growth investment strategy? At what point do you sell? Clearly from the evidence presented it is apparent that already retired investors cannot look at investment opportunities paying less than the S&P 500 dividend rate of 2.1%. That would be throwing money down on the hopes that maybe enough growth will occur to sell the investment in 1, 3, 5 or 10 years to fund your retirement for the next 1, 3, 5, or 10 years. What does the retiree do in the mean time?? Talk about risk? What if the market stays flat or falls for the next 5-10 years? It has happened only relatively recently. What does the growth angle do for you then….talk about risks??? Okay, a different strategy might be dividend AND growth strategy with a different set of metrics and a longer term time frame, but trying to mix strategies could be more risky and dangerous.
Hello Rom,
thx for your comment. I understand your concern, but even though I’m 100% convinced dividend investing is a strong strategy. However, in the end, money is money and I am not willing to give away my portfolio value in exchange of a higher yield. I rather withdraw a part of my capital but seeing an overall growth of my assets than getting a juicy dividend temporarily and see it cut and see my capital dropping like a rock. Examples of high dividend yield cutting their distribution (and make their capital drop at the same time) are legions. This is my only point. Once you retire, you don’t have the ability to generate future income, you depend on your nest egg. If you suffer dividend cuts, your capital will also be diminished.
I use a metric called Yield at Retirement (which is basically forecasted yield at cost) which I calculate as
Yield @ Ret = y*exp(g*t)
Where y is the current yield, g is the forecasted growth rate and t is the number of years to retirement. I feel that this gives me the right balance between yield and growth which will favour growth in my younger years and then yield as I get closer to retirement.
Fantastic! That is exactly what I use…only I did not name it “Yield at Retirement” which is a perfect name for it. After making future budget projections (for after retirement) and knowing the size of one’s portfolio, one can determine his/her’s YAR. Then one can use your formula to calculate required current yields. In my case, the current yield for my entire portfolio has to be around 4.4%. The only really foggy variable, IMO, is to try to forecast the divided growth rate. I use the last 5 years DGR trend line and then more or less divide by 2, since all the DGRs appear to be falling. DGRs are the least “guaranteed” variable for DGIs, but I am amazed at how often they are considered to be constants.
It’s interesting that there is so much discussion about Canadian banks in this comments section. They play a huge role in the construction of my personal portfolio.
Another source of yield that investors often overlook is real estate investment trusts. Some trade at significant discounts to book value on the fear that a housing bubble burst is imminent. A great opportunity to pick up some good yield on cost.
“Let’s assume you retire at the age of 65. On average, you will live another 20 years.”
Of course, many of us begin DGI in our 40s or earlier, so have many more that just 20-25 years of portfolio growth/income.
Hello Ironlife,
you are right, most of us have probably 40 yr+ investment horizon. But it is true we sometimes forget investors start dividend investing at a latter age.
Cheers,
Mike
Article gave me cause for pause…what growth rate is needed to achieve surpassing portfolio #2 with portfolio #1 in a shorter amount of time, wondering if you looked at that – i.e. in 5 or 10 years instead of 19 years.
And is there some sort of chart somewhere that we can look at that shows yield and growth so we know when to choose a lower yield with higher growth vs higher yield with lower growth? I’m still building my portfolio, am 59 and want income to grow and don’t want to have to tap into principal. I’m not as familiar with Canadian Stocks, are you from Canada, is that why everyone is talking about Canadian Stock?
Hello C.M.
I’m Canadian, but I would say that my readership is about 60% US and 40% Canadian. It seems Canadians are more concerned about yield vs growth vs retirement at the moment 🙂
Cheers,
Mike
Hi there. Just found this page. Any chance you can show your math for the scenarios? I might have run the numbers wrong but I’m coming up with it taking 10 years for a 3% yield with 6% CAGR to match up with a 5% yield with no growth.