Retiring on Dividend Income – the Right Strategy Can Make it Happen

Updated: 3/27/2024

 

Retiring on dividend income seems like a fallacy that’s simply not possible, unless you’re already wealthy. But in fact it can be accomplished if you implement the right strategy and stick with that approach for the long haul.

Introduction

Perhaps you’ve seen the videos or read the articles about living off of dividends. Easy as pie.

Go out and purchase a bunch of high-yield dividend stocks and then simply sit back and collect the fat checks that soon will start flowing into your bank account.

Admit it, this sounds just grand. Were that it could be true.

But….

Yes, there it is, right on schedule. Doubt! That part of you that is beyond a wee bit skeptical. The part that has you wondering just this very moment how it could be true and why it is that not everyone is taking advantage of this grand secret for their benefit.

Well, you should be skeptical. It does take a lot of work and some expertise. And there are still no guarantees.

That said, retiring on dividend income is doable and can lead to serious wealth building when done right and over time.

Today we are going to review what dividends are, how they work and should be used, issues to be aware of and avoid, and a strategy that’s capable of creating real wealth over the long haul.

What is a dividend

The term dividend is something you hear about in the financial media and within the markets quite a bit, but in fact it is misunderstood by many.

Simply stated, a dividend is a payment from a company to shareholders in the form of cash or shares of stock, according to Vanguard.

Many dividend-paying companies issue them on a consistent basis ranging from monthly (more limited) to quarterly (most common), semi-annually and annually. The company’s board can also elect to issue special dividends at any point in the year and for assorted reasons.

Companies announce dividends through the media to ensure the market, and shareholders, are aware a dividend has been declared and will be paid out in the near-term future.

A dividend is generally distributed from profits (not always) and is intended to reward loyal shareholders who own the company’s shares before the official ex-dividend date for the dividend. Doing so can demonstrate the fact that a company views itself strong in terms of its financial position, but that is not always the case.

Many shareholders (especially those in the accumulation stage pre-retirement, and those in retirement) prefer to own dividend stocks precisely in order to receive dividend payments issued by a company.

Key dates and terms

There are a number of key dates and terms associated with a corporate dividend that you need to be aware of when considering investment strategies that incorporate these unique instruments.

Announcement Date – also referred to as the declaration date, this is the date that the Board of Directors  for a company announce or declare a dividend.

Ex-Date – this is the date an investor must already own the stock by in order to receive a dividend payment for their shares. In order to receive the dividend you must own the stock at least one business day prior to the ex-date.

If you purchase a stock on or after the ex-dividend date, you are not eligible to receive the payment – you are purchasing shares that are “ex” or without the dividend. The price on ex-date will normally be adjusted downward and reflect that the shares purchased that date and thereafter are without the upcoming dividend payment.

Record Date – this is the date set by the company at which you must already be a shareholder of record. This can get confusing to investors new to dividend investing.

Trades in the U.S. settle on a T+2 settlement system, meaning once a trade to purchase or sell shares between investors is executed, it takes two business days for the actual trade to settle.

When it comes to dividends, you must be an owner of record by the record date, which is set one business day after the ex-date in order to qualify for the current dividend due to the T+2 settlement rule.

The key is to remember to buy shares (if you don’t already own them) one day or more in front of the ex-date, ensuring that on or before the record date you are a shareholder of record and will be due the upcoming dividend payment by the company.

Payment Date – this is the date when the company actually issues either cash or shares into the accounts of shareholders’ on record.

Dividend Yield – this is a figure that demonstrates how much of a dividend that a company pays out relative to its share price. It is expressed as a percentage – dividends paid in the year/stock price.

The yield changes daily depending on stock price. A declining stock price will increase the yield, while the inverse will be true in terms of yield for a company whose stock price is increasing – the yield will decrease.

In that manner, the yield can be deceptive. For investors looking for dividend income in their retirement portfolio, the actual dividend amount paid per share, along with the stability of the dividend paid by the company over longer periods (dividend history) can and often should be considered more important when performing an evaluation.

Why do companies use dividends

Public companies operate to serve a need or purpose, earn profits and reward their shareholders. The better they are able to serve their customers, operate efficiently and earn profits, the better they can reward their shareholders.

When it comes to rewarding their shareholders, there are two primary methods through which they do so.

First method – capital appreciation: When new and often for years after going public, companies engage in activities with a plan of growing themselves and becoming profitable.

By efficiently operating the company, management is able to grow the entity and influence favorable investor and market sentiment.

Fact is that achieving profitability can take years. This is especially true for younger and less mature companies. Whether profitable or not, these companies are referred to a growth stocks. Investors are primarily driven by the prospect of their shares increasing in price (value), which is referred to as capital appreciation.

Many companies fall into this category. Even when they achieve profitability, rather than pay out dividends from profits, they elect to retain those earnings in order to grow themselves through assorted activities and initiatives that will allow them to take more market share, introduce new products or services, and achieve more profitability over time.

These activities and increased profits tend to positively influence sentiment regarding the company, which in turn drives up share price, rewarding investors with increased capital appreciation.

Second method – dividends: more mature and profitable companies tend to deliver some amount of profits back to shareholders in the form of dividends.

These are primarily cash, but payments can be paid in shares of stock, as well.

Overall, dividends are meant to rewards investors for their loyalty and influence them to continue to hold their shares for the long term. The dividends are paid at a set price on a per-share basis. An example might be a cash dividend of $2.20 per share owned.

Not all div stocks are created equal

When it comes to utilizing dividends as part of a portfolio and an overall retirement plan, all assets  utilized (e.g., equities, bonds, funds, annuities, ETFs, dividend stocks) should be viewed as tools.

And you need to maintain a proper balance when it comes to the mix of those instruments, based on your needs, goals, risk appetite and situation.

We mentioned evaluating these instruments previously and this is an important step if you are an investor nearing or actually in retirement who is considering dividends.

First up, when considering dividend investing you need to plan on playing the long game – dividends are a long-term strategy.

A strategy incorporating dividends over a long period can absolutely provide investment income that can realistically partially pay a sizable portion of you bills in retirement.

Additionally, you need to do your homework and refrain from simply seeking out companies paying the highest amount or offering high-dividend yields.

One of the best ways to begin to evaluate is to look at their history, especially as it pertains to their dividends in the past.

A track record of consistently paying a dividend and increasing its size over time is a pretty good predictor that the company is efficiently operated and may be able to continue with their policy of stability and paying increasingly larger dividends going forward.

There are actually 3 lists of mature companies that have achieved “consistency standards” in paying and increasing the size of their dividends over long periods (along with other criteria), according to Sure Dividend:

Dividend Achievers are companies that have paid increasing dividends in 10 or more consecutive years. Current examples include the likes of:

• R. Horton, Inc.
• Allegion
• CDW
• And more

Dividend Aristocrats are companies that have paid increasing dividends for at least 25 consecutive years. Current examples include the likes of:

• Abbot Labs
• Cardinal Health
• Canadian Utilities Ltd.
• And more

Dividend Kings are companies that have paid increasing dividends for at least 50 consecutive years. Current examples include the likes of:

• Farmers & Merchants Bancorp
• Archer-Daniels Midland
• 3M Company
• And more

Mistakes

A common mistake for investors attempting to implement dividend strategies within their retirement portfolios is to focus on high-yields or high dividend payouts. As previously detailed, a high yield can often be due to an underperforming stock price, among other causes.

While the dividend yield might seem tempting, the underperformance in the stock price can often be attributed to problems the market sees in the company and its operations.

Moreover, a company paying a high dividend can be a warning sign the entity is experiencing problems and might not be able to continue to pay a robust dividend (even one at all) going forward.

Dividends of 7-, 8-, 9-percent and higher are certainly out there, but often when you dig into the stock you will see they aren’t consistent in terms of the payout or rate, and oftentimes can lag the markets in terms of stock price performance and capital appreciation.

Concentrating your retirement portfolio with high-growth dividends is often risky – more so than many realize. Such an approach is less stable and more unpredictable, leaving you unsure in terms of future payouts.

Another common mistake is failing to account for inflation. While a steady dividend is more desirable to one that fluctuates and can’t be counted on, a dividend that doesn’t grow will see its present-day value eroded over time due to inflation, even in short-term periods of just a couple years.

This can be exacerbated if the stock price doesn’t appreciate in value, further reducing the actual yield on the overall investment since first purchased (stock price + dividend, combined).

Preferred strategy

When it comes to a dividend income strategy for those saving for retirement, our head honcho – Troy Sharpe, CFP®, CPWA®, CTS®, Founder and CEO,  prefers the increasing income strategy.

This strategy utilizes companies that have demonstrated a track record of consistently paying and increasing their dividend for years and even decades. Those companies will often do everything they can to maintain that stability and their reputation.

They also offer a moderate (or better) return due to the way they consistently operate their company in a profitable fashion. This can lead to increased share price, delivering capital appreciation that works to the benefit of their investors.

Those two elements, combined with the practice of plowing all of the dividend income (or at least a portion if you need the cash) right back into the company is a great way to build wealth over time.

In doing so you increase your holdings, which leads to more profits in the form of dividend payments and increased capital appreciation, both based on the fact there are more shares owned.

When it comes to this strategy, or any involving dividends, Troy warns that you shouldn’t be comparing your dividend’s performance with that of the overall market.

“We have specific purposes for the tools we use in a retirement plan. Stable dividend stocks won’t often keep up with the S&P 500 index in a bull market,” he says. “But they also tend to not go down as much during market declines. They are typically more steady and consistent…less volatile.”

Conclusion

Dividend investing can be a great way to build wealth over time when done right, but it does take a fair amount of work.

You can’t just search out high-yielding stocks and expect to sit back and enjoy receiving those fat checks every quarter. In fact, sitting back and doing nothing can lead to uncertainty regarding your income strategy. Worse yet, this can increase your overall retirement portfolio risk.

This is especially true in terms of your portfolio allocation. As with any portfolio and the tools utilized, you have to diversify your holdings through proper allocation.

The same definitely holds true with dividend stocks – it can be easy to end up over-concentrated in a given area or sector, with a bunch of highly correlated stocks (may not even seem so on the surface) that leave you exposed to diversification risk.

Assessments, rebalancing, et. cetera. A lot of work. For most people this is beyond the time and effort required, or the expertise necessary.

In that light, you owe it to yourself to talk with someone who can help you look at options and strategies that will fit your needs when it comes to dividend income for your retirement. As well as the myriad considerations and decisions that go into retirement planning. And living in retirement.

At Oak Harvest Financial Group we can be here for you in that endeavor, and more. To help you create a dividend strategy that will serve you over the long haul.

If you are currently utilizing a retirement plan (either your own or one created for you), our team would be happy to review it to determine if it is capable of really meeting your goals.

Or we can assist you by creating a retirement plan capable of helping you to retire with confidence. We can build a holistic, comprehensive retirement plan addressing relevant issues, utilizing strategies that cover taxes, income, spending, healthcare, legacy, and more, customized to your family’s specific needs.

A plan created with the goal of ensuring you can successfully live out the retirement you envision.

If you are ready to take the next step and talk to a team of retirement planners who can advise on all your retirement needs, and who will put your interests first, Schedule a call today!

 

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