Troy Sharpe: Retirement income strategies, should you consider using a high dividend approach to generate your retirement income? What are the pros, what are the cons, and what do you need to be aware of when considering investments that pay high dividends or high interest?
I’m Troy Sharpe, CEO of Oak Harvest Financial Group, CERTIFIED FINANCIAL PLANNER™ Professional (CFP®), and host of The Retirement Income Show. I had a gentleman come in to see me recently, and he said, “Troy, I don’t think I really need your help. I’ve been listening to you on the radio for a few years. I like your message. I just wanted to come in for a second opinion, but I’m living off the interest of my portfolio. Like I said, I don’t think I really need your help, but I wanted to come and talk to you.”
We started to go through his portfolio, and the entire portfolio was comprised of oil and gas companies, master limited partnerships, some really high-paying real estate investments. The strategy that he was employing became very, very clear. He took all of his money, was heavily concentrated into this high dividend or high interest-paying stocks and bonds. His plan was to live off the interest of that portfolio. I asked him, I said, “How has the performance been over the past several years?” He shuffled around the question, he didn’t really want to answer it.
I already knew the answer, and the answer is it has not performed because in this type of economic environment high interest-yielding investments typically don’t perform well from a capital gain perspective. I want to show you what I mean more specifically. This is a cautionary tale to those of you who are considering employing a high dividend strategy with all of your money or have used it in the past. Hopefully, you can correct what you’ve been doing to have a more well-rounded and more diversified portfolio.
This is the S&P 500. It’s a five-year chart going from the end of 2015 here, all the way through the beginning of 2020. The S&P was around 2,000 here. Today, it’s up over 3,200. That’s more than a 50% gain in a five-year period. At the same time that the stock market has been doing this, when we look at your typical high dividend stocks, this is Exxon over the same 5-year period. The stock has went from about $90 a share to about $65 a share.
If we look at ConocoPhillips, another oil and gas company, the stock has went from about $61 a share to about $61 a share. It hasn’t really done anything in five years. If we look at OXY, Occidental Petroleum, it’s went from $80 a share down to $41 a share. All of these stocks, you could get a 4%, 5%, 6%, 7% dividend, but as we can see when the stock market went up in value, these have either stayed flat or most of them have went down.
One other asset class here, we call them master limited partnerships, and they typically pay even higher dividends, 7%, 8%, 9%, but as we can see here, this is the ETF, which is comprised– it’s essentially a bucket of several different master limited partnership investments. It’s went from $17 a share to $8 a share. We can’t have investments in our retirement portfolio just solely that pay high dividends because oftentimes the value or the capital appreciation of those investments simply doesn’t keep up with the overall stock market. Plus we don’t want to be overly concentrated into any one asset class simply to live off the interest income.
Now, one of the big things we need to be aware of when it comes to employing this type of strategy even if it sounds good, even if you’re like, “So what, Troy? All care is if I get my 6% dividend. That gives me all the income I need, and it’s a sound strategy.” No, it’s not, and one of the things– one of the main reasons why it’s not is because of inflation. If you have $50,000 of income today, and that’s all you need and you can get by on that, well, in 20 years from now, that $50,000 if you’re living off that 6% dividend, that’s only going to buy you about $25,000 worth of goods and services. Inflation erodes your purchasing power over time.
We need two components of return. We need the income component and retirement from dividends and interest, but we also need the capital appreciation component. This is very, very important. The longer we’re able to hold our investments over time, the more important the income component becomes, but over shorter timeframes, the value of your portfolio will be more heavily influenced by the capital appreciation component of the stock market returns.
Very, very quick summary here. High dividend stocks, you can use them as a part of your overall portfolio. Please don’t use them for your entire retirement income strategy. One, inflation can erode your purchasing power, but two, the economic environment we’re in where interest rates are likely to gradually increase over time, that puts pressure on these types of investments. You’ll see their value normally decline in price.
The reason is if you have a 5% dividend portfolio and interest rates are low, that 5% is pretty attractive. As interest rates rise, that 5% becomes less attractive. In order to sell it, you’re going to have to reduce the price for it to be more attractive to other people. Keep that in mind as well. These strategies don’t work well in a rising interest rate environment.
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