With the stock market continuing its rise, the dividend yields on many stocks are down. This combined with the continued low interest rate environment is putting major stress on those who want enough income in retirement so that they never run out of money.
Because of the issues I just cited, along with many others, more than half of those approaching retirement fear that they will run out of money. Because of this we have a record number of people in this country working into their 70s. There are also more people than ever before that have cut their expenses to the bone, moved in with their children, or have sold their home and moved into a low-cost apartment just so they are sure they won’t run out of money.
Needless to say, this isn’t the dream retirement that so many people had. Not only is this a tough state of affairs to be in, but the whole situation was likely entirely preventable for many of them.
This article is not going to recommend that people invest heavily in stock funds or ETFs for the rest of their lives. This strategy has gotten too many people into way too much trouble over the past 15 years. What I want to discuss today is how carefully selecting and investing in strong dividend paying stocks, such as AT&T (T) can pay off big time in the long-run and reduce stress immensely as movements in the stock price eventually barely matter.
Although I will focus on AT&T in this discussion, the strategy here applies to many companies that have a solid history of increasing (or at least not cutting) their dividends over time, even during recessions. Other companies that fit this mold are Coca-Cola (KO), Johnson & Johnson (JNJ), Exxon (XOM), AT&T (PG), and Wal-Mart (WMT).
Let’s take a look at what makes companies such as AT&T such a solid investment for retirement portfolios.
| Div. Yield | Div. Growth
Rate (3 Yr. Annualized) | Div. Growth
Rate (5 Yr. Annualized) | Growth of
Dividend (1/2008-12/2009) |
| 5.4% | 2.3% | 2.2% | 5% |
The first thing that normally jumps out at investors when it comes to AT&T is their oversized dividend yield of 5.4%. Their dividend yield certainly looks wonderful on the surface. But the dividend growth late has been lagging and has only been 2.2% (annualized) over the past five years. We must always take into account the dividend yield and the dividend growth rate when projecting future outcomes for dividend payers.
One thing that might surprise people is that AT&T did not cut its dividend during the dark days of 2008-2009. They actually managed to increase it by 5%, which is a good sign for a company that generally has cyclical revenues.
What I want to show today is how a dividend paying stock like AT&T can change a person’s entire retirement situation. I want to take a look at a 45 year old couple that has been scared out of the stock market and currently has everything invested in long-term treasury bonds at 3.2%. They currently have $400,000 saved. Let’s also apply an inflation rate of 2% for each year. They plan on retiring when they are 65. How much money can they expect to have when they retire if we take into account inflation? For this example I assumed half of their money was in a qualified, non-taxable account such as an IRA. They pay taxes at a 30% rate on their investment income and dividends are taxed at a 15% rate.
Here are the results for this couple if they keep all of their money invested in low-yielding treasuries:
| Beginning Value
Of Account | Ending Value
Of Account (Nominal $) | Ending Value
Of Account (Real $) | Real Annual Return After Taxes |
| $400,000 | $684,000 | $454,750 | 0.65% |
In 20 years their investments have only grown by a mere $54,750 if we reduce everything by the inflation rate. That is only 0.65% per year in real terms. I plugged in these numbers into our Retirement Planner and found that this couple would only have a 20% chance of not running out of money if they save $10,000 a year for the next 20 years, spend $45,000 a year in retirement and receive $35,000 a year in social security payments. This couple is headed for serious trouble.
Now let’s look at the case where they invest in a basket of dividend payers with characteristics similar to AT&T. It is important to note that I am not recommending investing in just one stock. I am recommending investing in a basket of solid dividend paying stocks that have characteristics similar to AT&T.
In this example I assumed a dividend yield of 5%, long-term dividend growth of 2.5%, and no increase in the stock price at all. I ran these numbers in our free online calculator called Dividend Yield And Growth.
| Beginning Value
Of Account | Ending Value
Of Account (Nominal $) | Ending Value
Of Account (Real $) | Real Annual Return After Taxes |
| $400,000 | $1,178,000 | $792,900 | 3.5% |
Now we’re talking some real money when they retire. They will have over $1.1 million (in today’s dollar terms) when they retire. Plugging these numbers into our Retirement Planner I found that they now have an 80% chance of never running out of money in retirement. It is important to keep in mind that I assumed no change in the stock price in this example. I wanted to show how just collecting the dividends from strong dividend growth stocks can have such a large impact.
Because of the time factor involved with dividend growth stocks it is of utmost importance to begin investing wisely when you’re relatively young. For those who are already in their 60s this strategy will not be as useful, although it can still be a significant part of their overall strategy.