Are you looking for a way to invest your money for retirement?
Or, are you looking to build a stream of passive income? An income that regularly rises to keep up with your ever-increasing living expenses?
What if that income was enough to make work optional? How would that change your life?
If you are seeking growth of your investments while also earning a stream of growing income, then look no further than dividend growth stocks.
Dividend growth stocks are the ultimate long term investment for retirement income for the following 3 reasons:
Reason #1 – Dividend Growers Offer Higher Returns Than Stocks That Pay No Dividends
Thousands of stocks pay cash dividends as way to distribute profits to shareholders. The best companies increase dividend payments year after year. Since 1921, these dividend growth stocks have contributed an excess return of 7.5% over stocks that paid no dividend at all. The real power driving this return premium is the increase in income each year as dividends are increased.
Over the 40-year period ending December 31, 2014, the average dividend paying stock generated a total return over 3.5 times more than stocks that did not pay dividends!
Reason #2 – Dividend Stocks Offer Higher Yields Than Bonds
Investors searching for income are forced to look beyond fixed income investments in today’s low interest rate world. Not long ago, an investor could invest in a 10-year US Treasury bond and get a decent income with little risk.
The chart below shows that the interest rate on an investment in a 10-year Treasury has dropped from a high of 15.84% in 1981 to just 1.60% on September 30, 2016.
If you look at this rate after inflation (which is currently 2.3%), you are left with a negative yield of -0.7%. In other words, if you are investing in 10-year Treasuries today, you are losing money after you factor in inflation!
So, what’s a conservative investor to do?!
Well, the first thing you have to ask yourself is: “what is the real risk with my investments?”
If you are investing with a time-frame of 10 years or more, then it is my belief that inflation will be a real threat to your portfolio.
The chart below shows you the impact of a 3% inflation rate.
So, if we assume you’d like to live on a nice, round number of $100,000, this chart shows you the future income you will need to maintain your lifestyle. After 30 years, and an inflation rate of 3%, you will need nearly 2.5 times the income you started with!
As you can see, a fixed income portfolio won’t take you very far with today’s low interest rates. Most investors will need to follow a plan that will grow their income throughout retirement.
Today’s retirees will need to invest differently than the retirees of the 80s and 90s. Back then, a retiree could build a laddered bond portfolio and enjoy yields of 5% or more. Today, it is tough to build a bond portfolio that will exceed inflation.
That doesn’t mean that bonds don’t have a role in your portfolio. Bonds will still act as a great diversifier and help minimize, or cushion, the possible downside volatility you will see in your stocks. But, don’t expect to see high income or growth from your bonds.
As you can see in the next chart, the dividend yield on an S&P 500 ETF is currently 2.11%. So, the US stock market is currently yielding more than the 10-year Treasury Bond!
But don’t just buy the market. Be selective by establishing your criteria for a strong dividend paying stock. Build a portfolio of stocks in a variety of industries and you have the potential to do quite well with your money over the next 10 years or more.
Reason #3 – Dividend Growth Stocks Have Lower Volatility
Volatility leads to some really bad decisions.
When stocks dive, investors are prone to panic-selling…leading to lower returns.
As investors, we want to look for the best returns with the lowest amount of risk, which is often expressed as volatility.
Dividend growth stocks have shown higher returns with lower risk than stocks that don’t pay a dividend. Furthermore, dividend growers also produce better results with less risk than companies that pay a dividend but don’t grow those dividends.
By owning dividend growth stocks, you are likely to experience less volatility.
Furthermore, if you’ve done your research on the companies you own, when volatility comes you can be confident that they are durable enough to withstand a recession and sustain their dividend.
BONUS PRINCIPLE: Time is a Volatility Killer
One more thing to think about is that as you extend your time horizon, you reduce the probability of losing money in the stock market. As you can see in the chart below, 94% of all 10-year periods since 1926 have had positive returns.
If you extend your time horizon to 20 years, you can have even more confidence that you will make money in the stock market. History doesn’t always repeat, and past performance doesn’t guarantee future results, but it’s good to know that there has never been a 20-year period where the S&P 500 has lost money.
These probabilities are why I have confidence saying that an investor is more likely than not to experience better results from investing in high quality dividend growth stocks than bonds over a time-frame of 10 years or more. Especially in today’s interest rate environment.
CAUTION: Some Dividend Stocks Are Expensive Right Now
Historically, we have seen that dividend stocks have offered a great way to invest to see returns better than the market and to generate increasing income. However, it is important to recognize that with low interest rates, investors’ search for yield has bid up the price of some dividend stocks, which may lead to lower returns in the coming years.
Before buying a stock, you will want to be sure the valuation is reasonable. A great place to start is by looking at the company’s P/E and P/B ratios relative to the company’s historical range, as well as other stocks in the market.
Today’s long-term investor should consider owning dividend growth stocks. I believe dividend growth stocks are the ultimate long-term investment for retirement income for these three reasons:
1) They have historically generated higher returns than non-dividend paying stocks.
2) They offer higher yields than bonds and can be a great alternative if your time horizon is 10 years or more.
3) They are less volatile than other stocks making it easier to endure corrections in the market.
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