Adam Zuercher

CPA, Certified Financial Planner, and Wealth Management Advisor based in Findlay, Ohio

3 Big Reasons Dividend Growth Stocks Are The Ultimate Long-Term Investment For Retirement Income

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2016-11-03 Blog ImageAre 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.

S&P 500 Stocks by Dividend Policy

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!

10 Year Treasury Interest Rates 9.30.2016

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.

S&P 500 Dividend Yield

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!

^SPY_dividend yieldchart

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.

Dividend Growers Have Less Volatility

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.

Time is a volatility killer

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.

Conclusion

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.

Want To Learn More?

I will be hosting a free webinar in the next few weeks where I will share a lot more about investing in dividend growth stocks. Click here to get more details on my free webinar:

“How to Build Wealth And Make Work Optional With Dividend Stocks”

Bitcoin Basics

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BitcoinBitcoins hit the virtual world in 2009 as a peer-to-peer payment system in open-source software format. Creator Satoshi Nakamoto (alias) designed Bitcoins to be “mined” by powerful computer equipment. As the pre-coded complex equations are solved, Bitcoins are rewarded to the miners. Said rewards decrease in units and will continue to do so until the number of Bitcoins to be mined expires in 2140. The finite number of Bitcoins creates a unique quality for this virtual commodity, one that flames the volatility and value of the Bitcoin.

Bitcoin requires little personal information making it a popular venue for subversive use. However, its lack of governmental ties or backing attracts international appeal.  In addition Bitcoins utilize a block chain recording system for each of its transactions creating a nearly unhackable design appealing to all users. Bitcoins are attracting the attention of governments and regulatory groups across the globe seeking to squeeze the anonymity appeal to those using Bitcoins for money laundering or other similar activities. Although the block chains remain untouched by hackers, virtual wallets have not had similar luck.

So how does it work?

Bitcoins can be mined, purchased on an exchange website or transferred from a family member or client/customer’s virtual wallet. All transfers are conducted online and in meticulous order recorded through a serious of links called block chains. Once acquired, Bitcoins are stored in the cloud version of a digital wallet or on your computer. New technology is quickly creating alternatives to the virtual wallet like the SmartMetric card that can be used just as a credit card would be.

With smart phone transfer apps, Bitcoins can be used anywhere in the world at anytime. Although they are more widely accepted online, new venues open daily. On February 12, 2014 Goodwill announced they will soon accept Bitcoins at their stores[1] joining several other store fronts which are mostly located in New York and California.

What is its Impact?

Bitcoin’s success depends on its perceived value and although it has the potential to unify global currencies, short-term speculation predicts that Bitcoin won’t replace current bank notes, but rather behave as a monetary transfer vehicle. Some view Bitcoins as currency, some as a commodity and others as a ledger. As a currency, bitcoins are a secure and anonymous way to purchase items and pay for services. Others consider the finite nature of the Bitcoin a prolific investment and trade it much like virtual gold. However the fear of Bitcoin hoarding and recent whispers of fraud surrounding Mt. Gox (a popular exchange site)[2] make for a volatile investment. Additionally, the clear lineage drafted by the block chains during each transfer are valued as a unique record-keeping and transaction validation system.

When all three traits are combined, Bitcoin displays powerful applications for future economic uses. It’s potential, unpredictable. In the words of SmartMetric, “At its current growth rate, Bitcoin may surpass PayPal and the Discover card in daily transaction volume by the middle of 2014.”[3]

[1] http://www.sfgate.com/business/article/Goodwill-stores-will-start-accepting-bitcoins-5229642.php

[2] http://www.pcworld.com/article/2096060/bitcoin-price-plunges-as-mt-gox-says-flaw-in-protocol-allows-fraud.html

[3] http://www.marketwired.com/press-release/smartmetric-ceo-issues-open-letter-on-the-future-of-bitcoin-otcqb-smme-1873248.htm

Rebecca Patterson's Economic & Investment Outlook

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This post is one of a series of notes on the sessions I attended at the AICPA’s 2014 Advanced Personal Financial Planning Conference. You can find links to all my notes from the conference here.

This past Monday (1.20.2014)  Rebecca Patterson, Managing Director and Chief Investment Officer at Bessemer Trust, presented her investment outlook to the attendees at the AICPA conference.

Rebecca opened her talk by asking us if we were anxious about 2014. About 1/2 the audience raised there hands (which means the other 1/2 are optimistic about 2014:-))

Risks, Worries & Concerns…

There are some good reasons for 1/2 of the advisors in the room to be nervous:

The Fed

Patterson believes that the Fed is the most important factor to watch in 2014 as it will likely be the primary driver of the markets. The Fed’s “QE” has been fueling higher stock prices. Last week the Fed balance sheet hit a new milestone…$4 Trillion. She thinks it’s likely that we will see the Fed continue to taper by reducing bond purchases at rate of $10 Billion per month. Will the end of easy money mean the end of rising stock prices?

It is important to remember that tapering isn’t tightening. Monetary policy is still easy and tapering remains a dovish stance.

However, there will be ripple effects from the Fed taper including:

  • higher longer-dated US Treasury yields
  • a stronger US Dollar
  • pressure on commodity prices
  • pressure on emerging markets

Washington

The US remains politically challenged.

  • Congress approval rating went from 9% to 12% in the last year…not very impressive! (the long-term average is 33%)
  • 2014 mid-term elections (House & Senate) may add to stock market volatility

Jobs

For the average American who loses their job today it takes 9 months to find a new job.

Government Debt

Governments don’t have much room for further fiscal stimulus.

Government Debt to GDP:

  • Japan >200%
  • Italy & portugal ~125%
  • US ~100%
  • France, Spain & Germany ~75%

Emerging Markets

Last week Brazil raised short-term interest rates (Fed’s equivalent) to 10.5%.

Emerging markets are unlikely to sustain a rally in the short-term. Valuations are attractive, but there are too many headwinds including the ripple effects of the Fed tapering.

The worst case for emerging markets: Yellen and the Fed turn out to be more hawkish than expected, and we see a repeat of last May and June where yields spike and the emerging markets come under pressure.

Watch the “Fragile Five” currencies that are under the most pressure against the US Dollar:

  1. The Brazilian real
  2. South Africa’s rand
  3. The Indian rupee
  4. Turkish Lira
  5. Indonesian rupiah

But, It’s Not All Bad…

Patterson’s most out of consensus view is that the US economy will surprise to the upside, despite all of her concerns.

The US economy is still recovering slowly, but it is moving in the right direction. Here are some things that lead Patterson to this optimistic outlook:

Exports

The US economy is currently at record exports. Why? Because the US Dollar is weak and demand from Europe and Japan is increasing.

Energy Independence

In 2008 the US produced 78% of the energy it consumed. Today, we produce 90% of the energy we consume.

Global Liquidity

…will continue to be very supportive for financial markets.

Inflation

Over the next five years we will see relatively higher inflation, but inflation is not a concern for 2014.

Europe & Japan

…are showing relative economic improvement.

China

…looks stable in the near-term, but longer-term challenges remain. China’s investment is nearly 50% of GDP, and household consumption is around 34% of GDP. China is faced with the challenge of rebalancing to a consumer based economy.

Valuations

Valuations
Presentation Slide from Rebecca Patterson, Managing Director and Chief Investment Officer at Bessemer Trust

US equity valuations are not at highs.

  • The 12-month Forward P/E of the S&P 500 is 15.4…a tiny bit above the long-term average, but not an egregious valuation.
  • This valuation is similar to the 2007 peak, but nowhere near the 200 peak of 25.2.

The market is fully priced, but Patterson wouldn’t sell stocks solely on this measure.

Market Positioning

From 1.1.2007 to 11.30.2013 cumulative net fund flows into bond funds have been $1.3 Trillion. Flows into equity funds have been $496 Billion. There was a reversal in 2013 as we started to see investors pull money out of bond funds and add to their stock funds. With interest rates as low as they are and the possibility of rising rates, this trend is expected to continue. Fund flows into equities are also likely to continue given the good year for stocks in 2013.

Profit Margins

In the near term, corporate profit margins are sustainable. Historically profit margins peak when wage growth hits 3.5%. We’re not there yet. We are a long way from meaningful wage inflation.

Conclusion & Portfolio Positioning

Patterson identified four reasons the market can go up despite valuations:

  1. Capital Flows
  2. Share Buybacks
  3. Higher Corporate Revenues
  4. Supportive Central Banks

So, what’s the bottom-line? Going into 2014 Patterson is positioning portfolios according to the following outlook:

  • Traditional Government Bonds: Down/Underweight
  • Credit: Sideways/Neutral
  • Commodities: Sideways/Neutral
  • Developed Market Equities: Up/Overweight
  • Emerging Market Equities and Debt: Sideways/Neutral
  • US Dollar: Up/Overweight
  • The firm currently has its largest overweight to equities in years.
  • “We have one of our biggest overweights in our portfolio to healthcare.”

Question: What’s your economic or investment outlook? Share your thoughts in the comments.

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2014 AICPA Advanced Personal Financial Planning Conference

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This week I attended the AICPA’s annual Advanced Personal Financial Planning Conference (#AICPAPFP). The conference is in Las Vegas, but I attended virtually. A huge “thank you” to the AICPA for offering the virtual option. I would love to see more conferences offer an online option (i.e. Morningstar’s annual Investment Conference).

This conference was, by far, the best I’ve attended in quite some time. Michael Kitces promotes it as one of the 8 best conferences for financial advisors, and the best conference for technical content. I couldn’t agree more. If you want to learn and improve your skills as an advisor, you will want to put this on the calendar for next year.

Save the date: January 19-21, 2015 at the Bellagio in Las Vegas.

Over the next few weeks I will be blogging my notes from the sessions I attended. Stay tuned to this page for link’s to all my notes.

Sessions I Attended Live

  • The Weight of the World Economy: Investment Outlook – Rebecca Patterson
  • Leaders Eat Last: Why Some Teams Come Together and Others Don’t – Simon Sinek
  • Manager Selection and Due Diligence – Stephen Horan
  • Social Media – Amy McIlwain
  • Breaking Barriers to Increase Business – Bill Grimes
  • Conversations on the Edge of Retirement – James Shambo & Bob Veres
  • Fixing Your Investment Committee – Tom Brakke
  • Opportunities of the Present, Crises of the Future – Peter Zeihan
  • The Effect of Attention, Emotions and Biases on Investment Decisions – Terrence Odean
  • Global Stock Market Valuation – Mebane Faber
  • Retirement Income Strategies – David Blanchett
  • The Six Dimensions of Excellent Client Service – Julie Littlechild
  • Best Planning Ideas Panel – Lyle Benson, Stephen Akers, Robert Keebler & Michael Kitces
  • Data Gathering: An Inside-Out Approach – Michael Kay
  • Political Update: View on Washington – Greg Valliere
  • Update 2014: Advanced Income and Estate Tax Strategies for the Mass Affluent – Michael Kitces
  • Think, Act and Invest Like Warren Buffett – Larry Swedroe

Question: What conferences do you attend? Please leave your favorites in the comments.

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