October 6, 2025 • 48 mins
The source provides an extensive guide on retirement planning using a dividend income strategy, emphasizing how regular company payments to shareholders can create a stable, passive income stream. The episode thoroughly outlines the necessary steps, beginning with assessing financial needs to determine the required portfolio size, and moves into building a diversified portfolio that includes dividend stocks, ETFs, and REITs. Furthermore, the explanation covers essential aspects of risk management, such as mitigating market and inflation risks, and discusses the importance of implementing a sustainable withdrawal strategy to ensure long-term financial security. Finally, the source presents a practical example and warns against common pitfalls, such as chasing excessively high yields or ignoring the impact of inflation.
“If you don't find a way to make money while you sleep, you will work until you die.”
Warren Buffett
“If you don't find a way to make money while you sleep, you will work until you die.”
Warren Buffett
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
Welcome back to the deep dive. We're here to cut
through the noise on complex planning topics. That's the mission,
and today we've got a really important one. We've gathered
a stack of research and.
Speaker 2 (00:10):
We're going deep, deep into structuring retirement entirely around investment income.
Speaker 1 (00:17):
Specifically zeroing in on the dividend retirement plan. That's our
focus exactly.
Speaker 2 (00:22):
You know, for a lot of listeners, the endgame isn't
just saving up.
Speaker 1 (00:25):
A pile of cash, right, It's more fundamental.
Speaker 2 (00:28):
It's about making that shift, that transition from being a
worker earning a salary to becoming well a portfolio owner
who's collecting income from those assets like collecting rent okay.
Speaker 1 (00:42):
And our goal today is to pull out the blueprint
for using those dividend payments, those regular payouts as your
main source of funds when you.
Speaker 2 (00:49):
Retire, the definitive strategy.
Speaker 1 (00:51):
So let's start with the basics, make sure we're all
on the same page. What exactly are dividends A.
Speaker 2 (00:55):
Good place to start. Dividends are simply payments that establish
companies make to their shareholders.
Speaker 1 (01:00):
Be people who own the stock.
Speaker 2 (01:02):
Right. It's usually quarterly and it's basically a share of
the company's profits being distributed.
Speaker 1 (01:07):
So you're literally getting a slice of the earnings just
because you own a piece of the.
Speaker 2 (01:11):
Company precisely, and that idea returning profit to the owners.
That's the bedrock of this whole retirement strategy.
Speaker 1 (01:19):
Okay, so the big picture here, the ultimate aim for
someone retiring this way.
Speaker 2 (01:24):
It's about security. It's securing a steady and ideally very
predictable income stream.
Speaker 1 (01:31):
One that can maybe supplement Social Security or a pension.
Speaker 2 (01:34):
Or even replace them entirely depending on the portfolio size.
When you structure it correctly, this approach can really deliver
financial stability. It offers genuine peace of.
Speaker 1 (01:44):
Mind because the cash flow is being generated, not just sent.
Speaker 2 (01:48):
Down exactly, generated not liquidated. That's a key distinction.
Speaker 1 (01:51):
I think that concept generated cash flow. That's really the
core appeal, isn't it. It's like the engine keeps running
without draining the fuel tank. We'll put Okay, let's dive
into section one them the core appeal. Why focus on
dividends for retirement? What makes them particularly suitable maybe compared
to other ways of getting income.
Speaker 2 (02:09):
Well, the number one benefit, the one you can't really
argue with, is creating a truly passive income stream passive
meaning meaning once you've done the upfront work, the research,
setting up the portfolio strategically, those dividend payments just.
Speaker 1 (02:24):
Show up like clockwork, hopefully.
Speaker 2 (02:27):
Often automatically deposited right into your account. It requires very
little ongoing effort compared to say, managing rental properties or
working part.
Speaker 1 (02:35):
Time, so the income is largely detached from your daily
time and effort.
Speaker 2 (02:39):
That's the ultimate goal, isn't it Income that doesn't depend
on your labor or trying to time the market perfectly.
Speaker 1 (02:44):
That definitely sounds appealing. But you know, the big worry
for retirees, the one that keeps people up at night,
is running out of money. Longevity risks absolutely. That usually
involves selling off your investments bit by bit, year after year.
How does a dividend strategy change that whole risk picture.
Speaker 2 (03:00):
It fundamentally shifts the focus. The goal becomes principal preservation.
Speaker 1 (03:05):
Protecting the original investment amount.
Speaker 2 (03:07):
Yes, and that's the huge strategic advantage here. Dividends are
paid from the company's profits, okay, which means they can
be distributed regularly without forcing you to sell the underlying
stock the asset itself.
Speaker 1 (03:20):
So the money machine stays intact.
Speaker 2 (03:22):
Exactly your initial capital, your principle. It stays invested, It
can continue to work for you, potentially grow over time,
and really importantly, it remains available for the long term
for unexpected future costs or maybe for leaving an.
Speaker 1 (03:37):
Inheritance, So it potentially sidesteps some of the anxiety around
that classic four percent withdrawal rule where you have to
sell no matter what the market's doing.
Speaker 2 (03:46):
Precisely, think about the contrast with say, managing a bond
portfolio for income. With bonds, yeah, you get the interest payments,
the coupon payments, but eventually that bond.
Speaker 1 (03:56):
Matures, right, you get your money back.
Speaker 2 (03:57):
You get the full principal amount back and a lumps
and then immediately you've got this task, maybe even in
anxiety inducing.
Speaker 1 (04:04):
One, figuring out what to do with.
Speaker 2 (04:06):
It, where and how do you reinvest that chunk of
principle safely just to keep the income going. It's a
constant cycle.
Speaker 1 (04:13):
The dividend stock owner doesn't have that specific.
Speaker 2 (04:16):
Headache generally, no sure the company, assuming it stays healthy,
just keeps paying the dividend. Your principle stays invested in
the stock, hopefully growing along with the business over time
you bypass that constant reinvestment pressure.
Speaker 1 (04:29):
Yeah, that need to keep re risking your principle with
bonds is definitely a burden. And thinking about the types
of companies that pay reliable dividends, there's sort of an
inherent quality there isn't there.
Speaker 2 (04:42):
Absolutely, We're generally not talking about speculative growth stocks or
volatle tech startups here now. The focus is typically on stable,
high quality companies, often.
Speaker 1 (04:51):
Called blue chips household names.
Speaker 2 (04:53):
Right, organizations with long histories proven financial discipline, often in
industries that are less sensitive to economic.
Speaker 1 (05:00):
Cycles, like what sort of industries.
Speaker 2 (05:01):
The utilities, consumer staples that things people buy regardless of
the economy, or healthcare things people need exactly. Their long
term commitment, sometimes decades long, to paying dividends provides a
really critical buffer against market volatility.
Speaker 1 (05:16):
So even if the overall market takes a nosedive, well,
people still.
Speaker 2 (05:20):
Need electricity, they still buy groceries, they still need medicine. Right,
These companies, because the essential nature of what they do,
often have enough cash flow resilience to maintain their dividend
payments even during downturns.
Speaker 1 (05:33):
You might even increase them.
Speaker 2 (05:34):
Some do and that offers real predictability when other parts
of the market might be in panic mode.
Speaker 1 (05:40):
Okay, that addresses market stability, but what about inflation, that
quiet erosion of purchasing power. If my dividend income just
stays the same year after.
Speaker 2 (05:49):
Year, it's value shrinks.
Speaker 1 (05:51):
You're absolutely right, So how does this strategy tackle that?
Speaker 2 (05:55):
This is where the strategy gets more sophisticated. It's not
just about collecting dividends. It's about implementing an inflation defense. Wow,
through the concept of dividend growth. A dividend payment that
stays flat static ultimately fails the long term retirement.
Speaker 1 (06:10):
Dest because costs go up exactly.
Speaker 2 (06:13):
A successful dividend retirement plan demands that you look beyond
just the highest immediate yield. You need to focus on
companies that have a proven track record of increasing their
dividend payout year after year after year.
Speaker 1 (06:26):
That annual raise is the key.
Speaker 2 (06:28):
That increase is the inflation hedge. It's crucial.
Speaker 1 (06:32):
And the research gives us some good labels for identifying
companies with that kind of proven track record, doesn't it.
These categories show resilience.
Speaker 2 (06:39):
Yes, we look for specific groups. First, the dividend aristocrats aristocrats.
These are companies, typically in the S and P five
hundred index, that have successfully increased their dividend for twenty
five or more consecutive years.
Speaker 1 (06:52):
Twenty five years straight. Think about what that means.
Speaker 2 (06:55):
It means they raise their payout through the dot com crash,
they raise it through the two thousand and financial crisis,
they raise it through the recent pandemic.
Speaker 1 (07:03):
That speaks volumes about their management and their business model.
Speaker 2 (07:06):
It really does. And then you have the absolute gold standard,
the dividend.
Speaker 1 (07:10):
Kings even better than aristocrats.
Speaker 2 (07:13):
Fifty or more consecutive years of dividend increases fifty years.
Speaker 1 (07:18):
That's incredible.
Speaker 2 (07:20):
It's a stunning track record. It doesn't happen by chance.
It reflects things like market dominance, really efficient operations, pricing power.
Speaker 1 (07:27):
The ability to pass on rising costs right.
Speaker 2 (07:29):
All things needed to consistently generate rising profits to fund
those rising dividends.
Speaker 1 (07:35):
The sources mention some examples.
Speaker 2 (07:37):
Yeah. Classic examples often cited are companies like Procter and Gamble,
Coca Cola decades of consistent growth, and that.
Speaker 1 (07:44):
Growth is what ensures your income stream keeps pace or
even outpaces inflation.
Speaker 2 (07:50):
Which is absolutely non negotiable. If your plan needs to
last thirty maybe forty years, your purchasing power must be protected.
Speaker 1 (07:58):
Okay, so the why is clear. Potential for financial freedom,
keeping your principle safe and fighting inflation through growth. Powerful combination,
it really is. But before anyone gets excited and starts
picking stocks, we need to build the foundation.
Speaker 2 (08:12):
Properly, absolutely critical.
Speaker 1 (08:13):
Let's move into section two. Building the foundation. This starts
with a really personal assessment, doesn't it.
Speaker 2 (08:19):
Step one is all about assessing your own financial needs,
and you have to be thorough here, no guessing.
Speaker 1 (08:26):
Determine exactly how much income you'll need in retirement, right.
Speaker 2 (08:30):
You hear rules of thumb like needing seventy percent or
eighty percent of your pre retirement income.
Speaker 1 (08:34):
Are those useful?
Speaker 2 (08:35):
You're a starting point maybe, But real planning needs a
detailed bottom up look at your expected expenses well kinns
of things everything anticipated health care costs which could be significant,
travel plans, hobbies, property taxes. Will your mortgage be paid
off or is that still a factor?
Speaker 1 (08:54):
You need specifics.
Speaker 2 (08:55):
You need specifics to get an accurate total annual expense number.
Speaker 1 (08:58):
Okay. Once you have that num, that total expense figure,
then comes the really crucial calculation.
Speaker 2 (09:05):
Yes, defining the income gap, Explain that you take your
total estimated annual expenses that you just calculated. Then you
subtract any income you already know. You'll have guaranteed income
like Social Security, so security, maybe a traditional pension, if
you're lucky enough to have one, perhaps payments from an
annuity you already own.
Speaker 1 (09:23):
Okay, expenses minus guaranteed income.
Speaker 2 (09:25):
That number left over that is your income gap. That's
the precise amount of money your dividend portfolio has to
generate for you reliably every single year.
Speaker 1 (09:35):
That's the target. But when you're figuring out that target,
we need some reality checks. Inflation came up before. Let's
put some numbers on that risk. Planning based on today's
costs is dangerous.
Speaker 2 (09:45):
It's a fundamental flaw if you ignore it. Let's use
the example from the research. Assume a pretty moderate three
percent annual inflation rate.
Speaker 1 (09:53):
Okay, three percent seems reasonable.
Speaker 2 (09:55):
If you figure out you need forty thousand dollars a
year to cover your expenses today US ten years, assuming
that three percent inflation each year, that same forty thousand
dollars will only buy what about twenty nine eight hundred
dollars buys today.
Speaker 1 (10:09):
Wow, that's a huge drop. Look at twenty five percent
loss in purchasing power over just a decade.
Speaker 2 (10:13):
It really hammers home why you need income that grows?
Why give it? In growth stocks are so much more
suitable than investments with static yields.
Speaker 1 (10:20):
Okay, point taken on inflation. Next reality check taxes. Income
is income, but the IRS treats different kinds differently, right,
and that affects your net income massively.
Speaker 2 (10:30):
You absolutely must understand the tax applications from the very beginning.
Speaker 1 (10:34):
How do dividends get taxed?
Speaker 2 (10:36):
As we'll get into more detail later, they generally fall
into two main buckets. You've got qualified dividends. Qualified these
are typically taxed at the lower long term capital gains
rates could be zero percent, fifteen percent, maybe twenty percent
depending on your overall income, much better than regular income
tax rates. On the second bucket, ordinary dividends, These get
taxed at your regular much higher income tax rate, same
(10:59):
as your salary ouch.
Speaker 1 (11:01):
So knowing the difference is key.
Speaker 2 (11:03):
It's crucial for optimization, and this is where talking to
a tax advisor becomes really important. Deciding where to hold specific.
Speaker 1 (11:11):
Investments like in a tax advantaged account versus a regular
brokerage account.
Speaker 2 (11:15):
Exactly. Making the right choices there can literally save you
tens of thousands of dollars in taxes over a thirty
year retirement. It's not a minor.
Speaker 1 (11:23):
Detail, definitely not Okay. Before we get to the big
calculation the portfolio size needed, there's one more piece of
the foundation, the safety net, the.
Speaker 2 (11:32):
Cash reserve, your emergency fund. This is non negotiable, right,
absolutely non negotiable portfolio insurance. Essentially, the recommendation is typically
to hold enough cash to cover six to twelve months
of your essential living expenses.
Speaker 1 (11:46):
Why is that so critical, specifically for a dividend strategy, because.
Speaker 2 (11:51):
Even the stocks of the most stable divid and paying
companies can and do experience temporary price drops the market fluctuates. Right,
You never want to be in a position where you're
forced to sell your valuable dividend paying stocks, your principle,
just to cover an unexpected bill, especially if the market
happens to be down at that moment.
Speaker 1 (12:10):
Selling low the worst case scenario.
Speaker 2 (12:12):
Exactly that cash reserve prevents that, it prevents forced selling
during market downturns. It lets your income producing assets recover
untouched while you handle the emergency.
Speaker 1 (12:21):
Makes perfect sense. Okay, safety net in place. Now for
step three, calculating the required portfolio size. This is where
the dream meets the math.
Speaker 2 (12:31):
It's the moment of truth translating that income gap number
into the actual nest egg size you need to build.
Speaker 1 (12:36):
How do we do that?
Speaker 2 (12:37):
The formula itself is quite simple, but the inputs you
choose are really strategic. The basic formula is portfolio size
equals the annual dividend income needed.
Speaker 1 (12:46):
That's the income gap we calculated.
Speaker 2 (12:48):
Right, divided by the average dividend yield you expect your
portfolio to generate.
Speaker 1 (12:52):
Okay, let's use the concrete example from the research to
make this real. If someone determines their income gap is
forty thousand dollars a year.
Speaker 2 (12:59):
They need for dollars and dividends annually, and let's.
Speaker 1 (13:02):
Say we target an average portfolio yield of four percent.
That seems like a reasonable target based of what you
said earlier.
Speaker 2 (13:08):
It is. So you take forty thousand dollars and divide
it by four percent or point zero four.
Speaker 1 (13:12):
Okay, forty thousand dollars divided by point zero four that
equals one million dollars.
Speaker 2 (13:17):
Exactly to reliably generate forty thousand dollars a year from
dividends with a four percent average yield, you need a
portfolio principle of one million dollars.
Speaker 1 (13:25):
That million dollar number can feel daunting. Why stick to
that three four percent yield target? Why not try to
find stocks yielding six percent or eight percent to need
a smaller portfolio.
Speaker 2 (13:34):
That's a really important question. It comes down to risk
management and sustainability. If you start chasing significantly higher yields,
say consistently about five percent or six percent, you are
almost always taking on more risk. Risk of what the
risk that the dividend could be cut because the company
isn't actually earning enough to support it, or the risk
(13:56):
that the company itself isn't financially stable. And the high
yield is a sign of distress, not strength.
Speaker 1 (14:02):
So the yield is high because the stock prices fallen often.
Speaker 2 (14:05):
Yes, that three four percent target yield range is generally
seen as the sweet spot. It balances generating a decent
level of immediate income with ensuring the long term stability
and crucially, the potential for that dividend growth we talked about,
which requires healthy companies.
Speaker 1 (14:21):
Right, You need profits to dividends. Okay, that one million
dollar target or whatever the calculated number is. For listeners
still maybe ten twenty years away from retirement, seeing that
number really highlights something powerful.
Speaker 2 (14:31):
The incredible power of starting early.
Speaker 1 (14:34):
Compounding time is the magic ingredient.
Speaker 2 (14:36):
It's irreplaceable. The sources had a great illustration of this
someone investing ten thousand dollars per year assuming a seven
percent average annual return starting at age thirty and continuing
consistently until.
Speaker 1 (14:48):
Age sixty five, So thirty five years of investing ten
dollars k year.
Speaker 2 (14:53):
That consistent effort could grow the portfolio to over one
point two million dollars. Wow. If you wait, if you
start the same planet age forty five instead of thirty,
the final number is drastically lower. Time is the most
powerful component in compounding, even more than the amount you
invest each year.
Speaker 1 (15:11):
That's a huge motivator to start now, even if it's
small amounts. And for people still in that building phase,
that accumulation phase, there is a practical tip too.
Speaker 2 (15:20):
Yes, maximize your tax advantage accounts first.
Speaker 1 (15:22):
Your iras, your four oh one k's in the US
or similar accounts elsewhere.
Speaker 2 (15:26):
Exactly, it's about structural efficiency. If you can have your
dividends reinvested and grow without having taxes take a.
Speaker 1 (15:32):
Bite out of them meach year, they compound faster.
Speaker 2 (15:34):
Much faster. Imagine one hundred dollars dividend if it's reinvested
as one hundred dollars inside of tax advantaged to account
versus maybe only eighty five dollars after tax is in
a regular approkerage account. That difference adds up enormously over decades.
It helps you reach that target portfolio size much more
quickly and easily.
Speaker 1 (15:49):
Okay, great advice. So we know the why, We know
how to calculate the how much. Now let's get into
the whats Section three. Architecting the portfolio. What are the
building blocks we need to assemble this income machine.
Speaker 2 (16:03):
The absolute guiding principle here has to be diversification. Rigorous diversification.
Speaker 1 (16:09):
Don't put all your eggs in one basket.
Speaker 2 (16:10):
Or even one type of basket. Now, we're aiming to
build a portfolio that generates consistent income, yes, but also
minimizes the risk that any single stock failing or anyone
sector having a bad decade derails the whole plan.
Speaker 1 (16:24):
So the different parts need to work together as.
Speaker 2 (16:27):
A cohesive unit balancing stability, growth potential, and reasonably high
current yield.
Speaker 1 (16:32):
Let's start with the core component component one dividend stocks themselves.
When picking individual stocks, what are the must have criteria.
Speaker 2 (16:39):
You're looking for? Financial strength, resilience. Focus on those blue
chip stocks we mentioned earlier, primarily in stable, less cyclical industries.
Companies that are proven they can navigate economic downturns. Consumer
goods think packaged foods or household products, healthcare, pharmaceuticals, medical devices,
regulated utilities providing essential services.
Speaker 1 (16:59):
The sources mentioned specific names.
Speaker 2 (17:01):
Yeah, examples like Johnson and Johnson in healthcare, Pexico and
consumer staples. Maybe a telecom like AT and T. Companies
with huge scale, established brands, strong market positions.
Speaker 1 (17:13):
And we keep circling back to the yield. What's the
target range again? For individual stocks?
Speaker 2 (17:19):
We stick to that general two five percent sweet spot.
You have to be really, really cautious about chasing yields
much higher than that.
Speaker 1 (17:26):
Why the caution.
Speaker 2 (17:27):
An extremely high yield, say eight percent, ten percent or more,
is often a warning sign. It might mean the stocks
price is cratered because the market thinks the dividend is unsustainable.
Speaker 1 (17:36):
A yield trap.
Speaker 2 (17:37):
It can be or might mean the company is paying
out way too much of its earnings as dividends, leaving
nothing for reinvestment or weathering tough times. You need to
ensure the yield is backed by solid financial health, not
just market desperation.
Speaker 1 (17:50):
Okay, so how do we check that sustainability. You mentioned
a metric earlier, the payout ratio.
Speaker 2 (17:55):
Yes, the payout ratio. This is a crucial piece of
announce ulas is for any dividend investor. Listeners really need
to understand this one.
Speaker 1 (18:04):
Okay, break it down for us. How is it calculated?
Speaker 2 (18:07):
It's actually pretty simple math. You take the total dividends
the company pays per share over a year h and
you divide that by the company's earnings per share or
EPs over the same period.
Speaker 1 (18:19):
So dividends divide by earnings. What does that percentage tell you?
Speaker 2 (18:23):
It tells you exactly what proportion of the company's profits
are being returned to shareholders in the form of dividends.
Speaker 1 (18:29):
And what's a good range for that ratio? What are
we looking for?
Speaker 2 (18:32):
The sources generally suggest aiming for a payout ratio below sixty.
Speaker 1 (18:35):
Percent sixty percent or less. Why that level.
Speaker 2 (18:38):
Let's say a company earns two dollars per share and
pays out one dollar per share in dividends. That's a
fifty percent payout ratio. Okay, that means the company retains
the other fifty percent of its earnings. That retained cash
gives them a cushion. They can use it to handle
unexpected costs, pay down debt, invest in future growth projects.
Speaker 1 (18:56):
Or keep paying the dividend even if earnings dip slightly.
Speaker 2 (19:00):
It provides a safety margin. It suggests the current dividend
level is sustainable and maybe even has room to grow.
Speaker 1 (19:06):
What if the ratio is much higher, say eighty percent,
ninety percent, or even over one hundred percent.
Speaker 2 (19:11):
If it's consistently above eighty percent, management has very little
room for error. Any hiccup in earnings could threaten the dividend,
and over one hundred percent. If the put ratio is
over one hundred percent, it means the company is literally
paying out more in dividends than it's earning and profit.
That sounds bad. It's mathematically unsustainable in the long run.
It means they're funding the dividend by taking on debt,
(19:32):
selling assets, or dipping into pass savings. That is a
huge red flag. Signaling a dividend cut is likely just
around the corner. You generally want to avoid those stocks aggressively.
Speaker 1 (19:42):
Okay, avoid high ratios, What about very low ratios? Is
ten percent or twenty percent always good?
Speaker 2 (19:48):
Not necessarily. While a very low ratio certainly means the
current dividend is safe, if it's consistently extremely low, say
under twenty percent for mature company, it might sometimes indicate
a different issue, maybe inefficient appital allocation. If a company
is generating tons of profit but just hoarding cash instead
of reinvesting it effectively or returning more to.
Speaker 1 (20:08):
Shareholders, you might question management strategy, right.
Speaker 2 (20:12):
Is that the best use of the company's capital. So
we're looking for that balance ratio maybe forty sixty percent,
reflecting both shareholder friendliness and prudent financial management.
Speaker 1 (20:22):
That nuance is really important. Okay, So that's individual stocks.
But picking stocks is hard and carries risk component too.
Helps with that. Dividend ETFs and mutual.
Speaker 2 (20:32):
Funds, Yes, this is the shortcut to diversification and often
a much lower stress approach for many investors.
Speaker 1 (20:38):
How do they work?
Speaker 2 (20:39):
These funds pool money for many investors to buy a
large basket of dividend paying stocks, sometimes hundreds of.
Speaker 1 (20:45):
Them, so you own a tiny piece of many companies.
Speaker 2 (20:48):
Exactly, which dramatically reduces the impact if any single company
runs into trouble. If one stock in the ETF cuts
its dividend, the overall yield of the fund barely registers
the change. It smooths out the ride.
Speaker 1 (21:00):
And the sources highlighted some specific ETFs focusing on different goals.
Let's compare two big ones mentioned, VIG and SCHD. What's
the difference?
Speaker 2 (21:11):
This choice really depends on where you are in your
investing journey and what you're prioritizing. VIG that's the Vanguard
Dividend Appreciation.
Speaker 1 (21:19):
ETF appreciation so growth exactly.
Speaker 2 (21:22):
Its specific mandate is to focus on companies with a
strong history of increasing their dividends over time. It prioritizes
that growth potential, often more than the.
Speaker 1 (21:31):
Current yield, So the starting yield might be lower.
Speaker 2 (21:34):
Typically, yes, vig's yield might be closer to two percent,
maybe a bit less sometimes, but the idea is that
the dividends it pays out will grow faster over the
long term, offering better inflation protection maybe ten fifteen years
down the road.
Speaker 1 (21:47):
Who is VG best suited for.
Speaker 2 (21:49):
Probably someone who is still maybe five, ten or more
years away from retirement. They're focusing on building future purchasing power.
Speaker 1 (21:56):
Okay, Now, compare that to SDHD. The schwab Us Dividend equity.
Speaker 2 (22:00):
SCHD takes a different tack. It aims for more of
a balance between current high yield and dividend growth. Right
It screens for stocks based on fundamental strengths, but also
tends to have a higher overall dividend yield than VG
right now, maybe close to three point five percent, sometimes
even four percent.
Speaker 1 (22:17):
So more income today, more.
Speaker 2 (22:18):
Income today, which makes it potentially better suited for someone
who's already retired or very close to it and needs
that cash flow.
Speaker 1 (22:25):
Now, what's the tradeoff?
Speaker 2 (22:27):
The trade off is often that the growth rate of
sehd's dividends might be slightly slower over the very long
term compared to a pure growth focused fund like VIJ.
Speaker 1 (22:36):
So the choice forces you to be honest about your priorities.
Speaker 2 (22:39):
Absolutely, are you optimizing for income today leaning towards SEHD
or maximum purchasing power in the future leaning towards VIG.
There's no single right answer. It depends on your situation, very.
Speaker 1 (22:50):
Clear, Okay, moving to component three, which often timeps investors
with even higher yields real estate investment trusts or rates.
Speaker 2 (22:59):
Ah yes, Why do.
Speaker 1 (23:00):
These typically offer such high dividend yields sometimes four percent,
five percent, even up to eight percent or more.
Speaker 2 (23:05):
It comes down to their special tax structure read's own
income producing real estate office buildings, malls, apartments, warehouses, and
by law, to maintain their favorable tax status, they are
required to distribute at least ninety percent of their taxable
income back to shareholders as dividends ninety percent minimum. This
structure allows the reed itself to avoid paying corporate income
(23:27):
tax on those distributed profits. But the result is that
huge amounts of cash flow directly to the investors the
shareholders as dividends.
Speaker 1 (23:36):
Sounds great, high yields, direct pass through of income. What
are the downsides or trade offs we need to be
aware of?
Speaker 2 (23:43):
There are a couple of key ones. First, re stock
prices can often be more volatile than traditional blue chip
dividend stocks. Why is that their valuations are closely tied
to the hell of the real estate market obviously, but
also very sensitive to changes in interest rates, which we'll
touch on more later.
Speaker 1 (23:58):
Okay, more volatility what else?
Speaker 2 (24:00):
Second, and this is really important for planning cats because
of how ret income is structured, it often includes things
like depreciation, pass throughs, or return of capital. The vast
majority of the dividends paid by reads are classified as
ordinary dividends.
Speaker 1 (24:14):
Not the favorable qualified dividends.
Speaker 2 (24:16):
Correct, they get taxed at your higher regular income tax rate.
So while they are fantastic cash flow generators, they can
be quite tax inefficient if you hold them in a
regular taxable brokerage account.
Speaker 1 (24:28):
So placement matters hugely for lates hugely.
Speaker 2 (24:32):
They are often prime candidates for tax sheltered accounts like
a roth IRA. More on that in the risk section.
Speaker 1 (24:38):
Okay, we have stocks, ETFs, reads. What's the final component
for stability? Component four? Bonds and fixed income?
Speaker 2 (24:47):
Right? We need some ballasts for the ship. Bonds or
other fixed income investments aren't primarily there to generate the
bulk of your income in this strategy.
Speaker 1 (24:54):
What is their role?
Speaker 2 (24:55):
Then? Their main function is stability capital preservation. They act
as shock ups or for the portfolio. How So, bonds
tend to be much less volatile than stocks or even reads.
They provide a source of reliable, low variance income and
help cushion the portfolio's value during stock market downturns.
Speaker 1 (25:12):
So if the stock market drops twenty percent.
Speaker 2 (25:14):
Your bond allocation should hold up much better, maybe even
gain value depending on the type, which helps stabilize the
overall portfolio value and provides funds for rebalancing or expenses
without selling stocks low.
Speaker 1 (25:26):
What kind of bonds we're talking about.
Speaker 2 (25:27):
Could be very safe options like US treasury bonds, maybe
tax advantage municipal bonds depending on your tax situation, or
diversified corporate bond funds that hold investment grade debt. The
key is their lower correlation to equities.
Speaker 1 (25:42):
Okay, bringing all these pieces together, stocks, ETFs, rates, bonds,
and what's the count? What's a reasonable starting point for allocation?
The sources suggested a model.
Speaker 2 (25:53):
Yes, a common balance structure recommended by advisors in the
materials is the sixty twenty twenty model.
Speaker 1 (25:57):
Sixty twenty twenty. What does that represent?
Speaker 2 (25:59):
It means sixty percent of the portfolio allocated to those
core dividend stocks and divid in ets. That's your engine
for growth and stable growing income.
Speaker 1 (26:07):
Okay, sixty percent in stocks.
Speaker 2 (26:08):
ATFS, then twenty percent allocated to reads. The slices there
specifically to boost the overall portfolio yield, taking advantage of
their higher payouts.
Speaker 1 (26:17):
Twenty percent ates yield, leaving.
Speaker 2 (26:19):
The final twenty percent allocated to bonds or potentially cash
equivalents like money market funds. This is your stability anchor,
the volatility dampener.
Speaker 1 (26:27):
Sixty percent stocks ATFS, twenty percent reads, twenty percent bonds
cash seems like a sensible mix.
Speaker 2 (26:33):
It provides good diversification across different asset classes, different sources
of income, varying risk profiles, and different sensitivities to economic
factors like interest rates. It's a solid starting.
Speaker 1 (26:43):
Template, a powerful template, indeed. But of course no plan
is without risk. We have to move beyond the ideal
setup and confront the real world challenges. Let's shift to
section four, navigating the trade offs and managing risks, because
even this well structured plan facestential headwinds.
Speaker 2 (27:00):
Absolutely. The first inescapable reality is market risk. Stock prices
go up and down. That's just inherent in owning.
Speaker 1 (27:07):
Equities, and even the best companies can fall on hard times.
Speaker 2 (27:10):
Exactly, even dividend aristocrats or kings can, in extreme circumstances,
be forced to cut their dividend if they face a
truly existential business crisis. It's not common for the best ones,
but it's possible.
Speaker 1 (27:21):
So knowing that risk exists, how does the careful dividend
investor actively mitigate it? Day to day year to year?
Speaker 2 (27:28):
Mitigation comes back to layering different types of diversification. First,
across sectors.
Speaker 1 (27:33):
Don't just own tech stocks, which is bank.
Speaker 2 (27:35):
Stock, right. You need exposure to healthcare, consumer staples, utilities, industrials, financials, energy,
et cetera. Spreading bets across the economy.
Speaker 1 (27:43):
And diversification across assets.
Speaker 2 (27:45):
Yes, using that mix we discussed stocks, ETFs, reets, bonds,
and within stocks owning a sufficient number of individual holdings.
If you're picking stocks yourself.
Speaker 1 (27:55):
How many is enough?
Speaker 2 (27:57):
The general guidance is often twenty to thirty individual stocks,
well diversified across sectors to significantly reduce single stock risk,
or much simpler, just use broadly diversified ETFs.
Speaker 1 (28:08):
And beyond diversification, active monitoring is key.
Speaker 2 (28:11):
You need to keep an eye on the underlying fundamentals
of the companies you own or the sectors your ETFs.
Focus on checking things like our earning still growing, is
the company taking on too much debt? Is that crucial
payout ratio staying within the save zone we talked about
below sixty seventy percent. Complacency is risky.
Speaker 1 (28:27):
Okay, Monitoring fundamentals mitigates company specific risk. Let's revisit inflation risk,
which you call the main long term threat. Remind us
how dividend growth is the specific antidote here.
Speaker 2 (28:39):
It bears repeating because it's so central. If your income
stream is flat, inflation will erode your purchasing power over time,
You'll be able to buy less and less each year.
Speaker 1 (28:49):
Dividend growth combats that directly.
Speaker 2 (28:51):
It's your primary defense within this strategy. Think about it.
If you own a stock yielding three percent today, but
the company reliably increases its dividend payment by say five
percent each year, your personal yield on your original investment
is actually increasing every year. That five percent growth in
the dividend payment is likely outpacing the long term average
(29:12):
inflation rate of maybe two three percent.
Speaker 1 (29:14):
Can we see the math on that?
Speaker 2 (29:15):
Sure, if you reinvest those growing dividends, that stock initially
yielding three percent with five percent annual dividend growth could
effectively be yielding closer to four point eight percent on
your original cost basis after about.
Speaker 1 (29:25):
Ten years, so your income stream is actively growing faster
than inflation.
Speaker 2 (29:29):
That's the goal. It ensures your retirement income maintains or
even increases its real purchasing power over decades. This is
why prioritizing companies with a history and capacity for future
dividend growth is often more important than just grabbing the
highest current yield you can find.
Speaker 1 (29:46):
That really underscores the discipline needed, especially for someone needing income.
Speaker 2 (29:50):
Now.
Speaker 1 (29:51):
It's tough to prioritize future growth over immediate cash flow.
Speaker 2 (29:54):
It is, but it's essential for long term success.
Speaker 1 (29:57):
Okay, Next, risk interest rates sensitive. This has been a
big topic recently. How do rising interest rates affect a
dividend portfolio?
Speaker 2 (30:05):
Rising rates change the relative attractiveness of different investments. When
interest rates go up significantly, like they have recently, safer
fixed income investments like CDs, money market accounts, or government
bonds start offering much more competitive yields than they did before. Okay,
Suddenly an investor might look at a dividend stock yielding
say four percent, which carries stock market risk, and compare
(30:26):
it to a virtually risk free treasury bill yielding five percent.
The T bill looks pretty.
Speaker 1 (30:32):
Good, So money flows out of dividend stocks, some of
it does.
Speaker 2 (30:35):
Yes, demand for dividend stocks can soften as investors shift
towards safer, now higher yielding alternatives. This can put downward
pressure on dividend stock prices, even if the companies themselves
are doing fine.
Speaker 1 (30:49):
And you mentioned earlier that reads are particularly vulnerable to
rate changes, why is that.
Speaker 2 (30:53):
Yeah, Reads often get hit with a double whammy when
rates rise. How So, First, their business model usually involves
borrowing money to buy and develop properties. When interest rates
go up, their borrowing costs increase directly. That squeezes their
profit margins.
Speaker 1 (31:08):
Makes sense. What's the second hit?
Speaker 2 (31:10):
Second, Because reads are primarily valued for their high dividend yields,
investors often view them as bond proxies or bond substitutes. Okay,
So when the yields on actual safer bonds rise significantly,
investors are very quick to sell their reed holdings and
move that money into the newly attractive bonds. This rapid
shift in capital flow can lead to sharper price drops
(31:31):
in the red sector compared to other dividend.
Speaker 1 (31:33):
Stocks, so be aware of that heightened sensitivity if you
hold reates. Finally, let's circle back and really nail down
the tax risk management piece. How do we strategically place
assets to minimize the tax bite?
Speaker 2 (31:47):
This is crucial for maximizing your spendable income. Remember the
two types of dividends first, qualified dividends.
Speaker 1 (31:55):
The ones tax at lower.
Speaker 2 (31:56):
Rates right, typically generated by holding common stocks of US
companies and some foreign ones for a sufficient period. Taxed
at those lower long term capital gains rates zero percent,
fifteen percent, or twenty percent.
Speaker 1 (32:09):
Where should these ideally be held?
Speaker 2 (32:11):
Because those tax rates are already relatively low. The common
advice is often to hold these types of stocks or
ETFs that generate primarily qualified dividends in your regular taxable
brokerage accounts. You get the benefit of the lower.
Speaker 1 (32:23):
Rate directly okay, qualified dividends and taxable accounts.
Speaker 2 (32:26):
That leaves the other kind, ordinary dividends. These are the
ones tax at your higher ordinary income tax rates.
Speaker 1 (32:30):
Just like salary which investments generate these mostly primarily.
Speaker 2 (32:34):
Reads as we discussed, also interest from most bonds and
bond funds and distributions from certain other paths through entities
like master limited partnerships MLPs.
Speaker 1 (32:43):
Where do these belong?
Speaker 2 (32:44):
These are the perfect candidates for your tax advantaged accounts,
especially WROTH accounts like a ROTH IRA or WROTH four
one K if possible.
Speaker 1 (32:52):
Why Roth specifically.
Speaker 2 (32:54):
Because with a WROTH, qualified withdrawals and retirement are completely
tax free. By holding your high yielding reds or bond
funds inside WROTH, you effectively eliminate the tax drag on
that income altogether. That five percent or six percent yield
from a RED actually becomes five percent or six percent
spendable income instead of being reduced by maybe twenty two percent,
twenty four percent or more in tax is if held taxable.
Speaker 1 (33:16):
So qualified dividends taxable account ordinary dividends like responds tax
advantaged account ideally wrong.
Speaker 2 (33:22):
That strategic placement is a key optimization lever in this
whole plan. It makes a real difference to your bottom line.
Speaker 1 (33:27):
Excellent clarification. Okay, we've built a portfolio. We understand the
risks and how to mitigate them. Now for the payoff.
Let's move smoothly into section five implementation withdrawal and maintenance.
We're officially retiring and turning on the income tap.
Speaker 2 (33:44):
Right, the focus shifts from building the asset base to
actually using it to live on. This starts with deciding
on your withdrawal strategy.
Speaker 1 (33:52):
What's the simplest, Maybe the ideal approach.
Speaker 2 (33:55):
The simplest and arguably the most sustainable. If your portfolio
is large enough, is the dividend only withdrawal.
Speaker 1 (34:01):
Strategy sounds straightforward? What does it mean?
Speaker 2 (34:04):
It means exactly what it sounds like. You live only
on the dividend income generated by the portfolio. You don't
touch the underlying principle at.
Speaker 1 (34:11):
All, So the original shares or fund units remain untouched.
Speaker 2 (34:15):
Great, the dividends get paid into your account, You withdraw
that cash to cover your expenses, and the principle remains invested,
hopefully continuing to grow and generate more dividends over time.
Speaker 1 (34:25):
When does this work best?
Speaker 2 (34:27):
It works perfectly if the natural yield of your portfolio
is high enough to cover your entire income gap. Using
our earlier example, if you need fifty thousand dollars a
year and your one point twenty five million dollar portfolio
happens to yield exactly four percent, generating fifty thousand dollars
in dividends, you just spend the dividends. Your principle never
(34:48):
has to shrink. That's the ideal sustainability model.
Speaker 1 (34:51):
But what if there's a shortfall. What if the dividends
don't quite cover all the expenses, or maybe the market
has a rough year and some companies freeze dividends.
Speaker 2 (34:59):
That's a common scenario. In that case, you'd likely shift
to more of a total return approach, or what we
can call supplementing.
Speaker 1 (35:05):
How does that work?
Speaker 2 (35:06):
You take all the dividend income you receive, and then
you cover the remaining expense shortfall by selling a small
calculated portion of your portfolio's.
Speaker 1 (35:13):
Principle, selling some shares or fund units.
Speaker 2 (35:16):
Right, maybe you need to sell just one percent or
perhaps two percent of your total portfolio value each year
to bridge that gap between the dividends received and your
total spending needs.
Speaker 1 (35:25):
Is that risky?
Speaker 2 (35:26):
It has to be done very carefully and deliberately. The
goal is still to preserve the vast majority of the
principle over the long term. If your income gap is
relatively small compared to your portfolio size, selling one two
percent a year is generally considered quite sustainable.
Speaker 1 (35:41):
But if you find yourself needing to sell, say six
percent or seven percent of your principle each year on
top of dividends, then you likely have.
Speaker 2 (35:48):
A structural issue. Either your expenses are too high or
your portfolio isn't large enough that rate of withdrawal significantly
increases the risk of running out of money.
Speaker 1 (35:57):
Which brings us neatly to that famous benchmark for sustainable
draws from any kind of retirement portfolio, dividend focused or not,
the Safe withdrawal rate or SWR.
Speaker 2 (36:07):
Yes, the SWR concept is absolutely fundamental here, regardless of
whether your income comes purely from dividends or a mix
of dividends and principal sales.
Speaker 1 (36:16):
What is that generally accepted SWR range.
Speaker 2 (36:19):
It's typically defined as withdrawing around three percent to four
percent of your portfolio's initial value in your first year
of retirement, and then adjusting that dollar amount upward for
inflation each subsequent year.
Speaker 1 (36:30):
Where does that three four percent number come from? Is
it just a guess?
Speaker 2 (36:33):
Not at all. It's based on extensive historical research and
financial modeling. The most famous piece of research is probably
the Trinity Study conducted by orte three finance professors at
Trinity University back in the nineties, though it's been updated
and replicated many times since.
Speaker 1 (36:48):
And what did the Trinity study find regarding that four
percent rate? Which is often cited.
Speaker 2 (36:53):
They analyze decades of historical US stock and bond market
returns and inflation rates. They ran simulations testing different withdrawal
rates over typical retirement periods, usually thirty years.
Speaker 1 (37:05):
What was the conclusion.
Speaker 2 (37:06):
They found that withdrawing four percent of the initial portfolio
value and then adjusting that dollar amount for inflation each
year had a very high probability of success, meaning the
portfolio is highly likely to last for at least thirty years,
even if retirement started right before a major market crash.
Speaker 1 (37:22):
Like ninety five percent success rate or higher in many scenarios.
Speaker 2 (37:26):
Exactly so for the dividend investor, whether you're living off
dividends alone or supplementing by selling principle, keeping your total
withdrawal dividends plus principal sales within that three four percent
as WR zone is the critical boundary. It's the key
to long term income sustainability versus risking premature depletion of
your funds.
Speaker 1 (37:47):
So that three four percent figure is really the guardrail
for the whole plan. Okay, withdrawal strategy set, but retirement
isn't set it and forget it right. There's ongoing work needed.
Speaker 2 (37:58):
Absolutely. Step six and seven are all about out continuous discipline, monitoring,
and maintenance. This isn't a one time setup.
Speaker 1 (38:04):
What does that involve? Annually?
Speaker 2 (38:05):
At least once a year. You need to sit down
and review and rebalance, look at how your investments have performed.
Speaker 1 (38:10):
Check on those fundamentals again.
Speaker 2 (38:12):
Yes, identify any holdings that are consistently underperforming or critically
any company that has cut its dividend. A dividend cut
is almost always a strong signal to reconsider holding that stock.
It indicates potential financial distress.
Speaker 1 (38:25):
So sell the cutters generally.
Speaker 2 (38:27):
Yes, replace them with stronger candidates. And rebalancing means adjusting
your allocations back to.
Speaker 1 (38:32):
Your target back to that sixty twenty twenty.
Speaker 2 (38:34):
For example, right if your stock's had a great year
and now represent seventy percent of your portfolio, well bonds
are down to ten percent. Rebalancing means selling some of
those appreciated stocks and buying more bonds to get back
to your sixty twenty target mix. This forces you to
sell high and buy low, and it manages.
Speaker 1 (38:50):
Risk and staying informed. Generally, you have to keep abreast.
Speaker 2 (38:53):
Of the bigger picture, monitor economic trends where interest rates
might be heading overall corporate earning's health. Being informed helps
you anticipate potential risks or opportunities.
Speaker 1 (39:04):
And one last piece of planning, especially if leaving money
to errors is important.
Speaker 2 (39:08):
Estate planning becomes relevant. If preserving that dividend paying principle
for the next generation is a key goal, you need
to consider things like setting up trusts or planning how
shares might be gifted efficiently over time. Integrating the dividend
plan with your estate plan is crucial for legacy goals.
Speaker 1 (39:24):
That makes sense. Okay, we've covered a lot of ground,
from theory to practical steps to really cement all this,
let's walk through the hypothetical case study from the sources
Jane's plan. This brings it all together.
Speaker 2 (39:35):
Great idea. Jane is fifty five years old and she's
planning to retire in ten years at age sixty five.
Speaker 1 (39:41):
Okay, what are her income needs?
Speaker 2 (39:43):
She's done her homework and calculates she'll need a total
annual income of sixty five thousand dollars to live comfortably
in retirement.
Speaker 1 (39:49):
Sixty five thousand dollars total. Does she have any other
income sources?
Speaker 2 (39:53):
Yes, she expects to receive about fifteen thousand dollars per
year from social Security.
Speaker 1 (39:57):
Okay, so sixty five thousand dollars needed min fifteen thousand
dollars from social Security. That leaves her income gap.
Speaker 2 (40:03):
Her income gap. The amount her portfolio needs to generate
is fifty thousand dollars per year.
Speaker 1 (40:08):
Fifty thousand dollars annually from dividends and door withdrawals. If
she targets that four percent average, you'll be discussed what's
her ultimate portfolio size? Goal?
Speaker 2 (40:16):
To generate fifty thousand dollars a year at a four
percent yield fifty thousand dollars four, Jane needs a target
portfolio value of one million, two hundred and fifty thousand
dollars by the time she retires at sixty five.
Speaker 1 (40:26):
One point twenty five million dollars. That's her number. Where
is she now at age fifty five?
Speaker 2 (40:31):
She currently has six hundred thousand dollars invested Okay, six
hundred dollars.
Speaker 1 (40:34):
Now needs the dollar twenty five dollars and ten years.
Can she get there?
Speaker 2 (40:38):
The projection assuming she continues to save and achieves a
realistic seven percent average annual return with dividends reinvested during
these final ten accumulation years, huh huh, is that her
portfolio is expected to grow to approximately one million, hundred
ninety seven thousand dollars by age sixty.
Speaker 1 (40:52):
Five alum million hundred and ninety seven thousand dollars, So
really close to her dollar and twenty five hundred target,
but just a.
Speaker 2 (40:59):
Little bit short. Exactly, very close, but not quite there
based on projections.
Speaker 1 (41:02):
Now, let's look at how she plans to allocate the
one point one nine seven million dollar portfolio at retirement.
Using the model we discussed, she.
Speaker 2 (41:09):
Decides to adopt that diversified sixty twenty twenty approach. Okay,
so sixty percent seven hundred and eighteen thousand, two hundred
dollars goes into a mix of dividend growth and broader
dividend ETFs like maybe SHD, targeting an average yield of
around three point five percent from this sleeve.
Speaker 1 (41:23):
Sixty percent in ETFs than the reads.
Speaker 2 (41:26):
Twenty percent two hundred three doe thousand, four hundred dollars
goes into higher yielding reads, perhaps including names like realty income,
aiming for a higher yield of about five percent from
this portion.
Speaker 1 (41:34):
And the last twenty percent the.
Speaker 2 (41:36):
Final twenty percent two hundred and thirty nine thousand, four
hundred dollars goes into stable bond funds expected to yield
around two percent for safety instability.
Speaker 1 (41:42):
Okay, so she has those three buckets with different target yields.
If you blend those allocations and yields together, what's her
projected overall portfolio yield?
Speaker 2 (41:50):
When you calculate the weighted average point six zero three
point five percent plus point two zero five point zero
percent plus zero point two zero two point zero percent,
her total portfolio is expected to yield proximately three point
eight percent overall.
Speaker 1 (42:03):
Three point eight percent. Now, let's look at the income reality.
When she retires at sixty five, her portfolio is one million,
one hundred and ninety seven thousand dollars at a three
point eight percent yield. How much dividend income does that
generate annually?
Speaker 2 (42:15):
One million, one hundred ninety seven thousand dollars times point
zero three eight equals forty five thousand, four hundred eighty
six dollars per year in expected dividend income.
Speaker 1 (42:23):
Okay, forty five thousand, four hundred and eighty six dollars
from dividends.
Speaker 2 (42:26):
But wait, she needs fifty thousand dollars to cover her
income gap.
Speaker 1 (42:29):
Got it all. This is where the supplementing strategy comes
in perfectly and safely. She needs to cover that four thousand,
five hundred and fourteen dollars gap by selling a small
amount of principle each year.
Speaker 2 (42:37):
How much does she have to sell relative to her
total portfolio?
Speaker 1 (42:40):
This is the key point. Selling four thousand, five hundred
and fourteen dollars represents withdrawing only about point three eight
percent of her total one million, one hundred ninety seven
thousand dollars portfolio principle each year. Four thousand, five hundred
fourteen seven one million, one million, one hundred and ninety
seven thousand dollars point three eight percent.
Speaker 2 (42:56):
That's tiny, It's incredibly small. Her total withdrawal rate is
the three point eight percent from dividends plus LUs the
point three to eight percent from principal sales, for a
total of four point one eight percent, which is.
Speaker 1 (43:08):
Right around that four percent safe withdrawal rate threshold exactly.
Speaker 2 (43:11):
It's well within the sustainable range. This very small principle
withdrawal is highly unlikely to deplete her portfolio over a
long retirement.
Speaker 1 (43:19):
The plan works, and her risk management is built in too.
Speaker 2 (43:22):
Absolutely. Jane manages market risk by using diversified ETFs and
reeds covering maybe ten different economic sectors. She plans to
monitor payout ratios. She maintains a separate cash reserve of
fifty thousand dollars covering almost a year of her portfolio
withdrawals to avoid selling during downturns, and the tax planning. Crucially,
she plans to hold those higher yielding rates which generate
(43:44):
ordinary income insider roth IRA to maximize your tax efficiency.
Speaker 1 (43:48):
Just as we discussed, so, Jane's plan really puts all
the pieces together. It's a realistic, well structured example.
Speaker 2 (43:53):
It's a fantastic illustration of how all these concepts needs assessment,
portfolio calculation, diversification, yield targeting, withdrawal strategy, and risk management
come together in a workable retirement plan.
Speaker 1 (44:05):
Definitely clarifies the process. Okay, as we approach the end
of this deep dive, let's crystallize the absolute must dues
for anyone considering this strategy. What are the essential takeaways?
Speaker 2 (44:15):
Let's boil it down. First, you must accurately assess your
retirement income. Needs to define that crucial income gap. No
shortcuts there, got it. Step one, know your number. Second,
calculate the portfolio size required to fill that gap, using
a realistic sustainable average dividend yield target, probably in that
three four percent range.
Speaker 1 (44:35):
Step two, know your target portfolio size.
Speaker 2 (44:38):
Third, build a broadly diversified portfolio, cross stocks, ETFs, maybe reads,
and bonds. Critically prioritize companies with a history and capacity
for dividend growth to combat inflation over the long haul.
Don't just chase the highest current yield.
Speaker 1 (44:53):
Step three, build diversified, focus on.
Speaker 2 (44:55):
Growth, and finally, fourth, implement and stick to a conservative
withdrawal strategy. Keep your total withdrawals, whether just dividends or
dividends plus principle, within that sustainable three percent to four
percent safe withdrawal rate zone. Discipline is key.
Speaker 1 (45:09):
Assess needs, calculate size, build diversified with growth focus, stick
to SWR excellent summary. Now, what about the big mistakes,
the common pitfalls that trip people up and derail this
kind of plan.
Speaker 2 (45:22):
Number one is definitely chasing yield, getting seduced by stocks
or funds yielding six percent, eight percent, ten percent or
more without doing extremely thorough due diligence. There often yield traps,
high risk disguise as high return and prone to dividend cuts.
Speaker 1 (45:37):
Avoid the siren song of unsustainable yields. Pitfall number two.
Speaker 2 (45:40):
Lack of diversification. Concentrating too much risk in just a
handful of stocks, or maybe too heavily in a single
sector like tech or energy. One bad apple can spoil
the whole barrel if you're not diversified.
Speaker 1 (45:50):
Diversified, diversified, diversify.
Speaker 2 (45:52):
Pitfall number three ignoring inflation. This happens if you focus
only on current income and fail to prioritize dividend growth.
Your purchasing power will steadily decline over retirement. If your
income doesn't grow. You must build in that inflation protection
from day one.
Speaker 1 (46:08):
Focus on growth, not just today's yield. And the final pitfall.
Speaker 2 (46:13):
Overdrawing the portfolio. Getting complacent or panicked and consistently withdrawing
more than that four percent, maybe five percent or more
of your portfolio value each year. That drastically increases the
odds you'll run out of money too soon.
Speaker 1 (46:26):
Stick to the plan, avoid chasing yield, diversify, properly, prioritize growth,
and don't overdraw.
Speaker 2 (46:32):
Got it.
Speaker 1 (46:32):
Those are the big ones to watch out for.
Speaker 2 (46:34):
This has been incredibly thorough. We've gone from the basic
appeal of dividends all the way through to detailed implementation
and risk management. It really does offer a different perspective
on retirement funding, less about spending down savings, more about
collecting income from assets you own.
Speaker 1 (46:50):
It's a powerful mindset shift. And you know what's really
fascinating about this whole dividend retirement plan strategy.
Speaker 2 (46:55):
Is that it's true long term success really hinges on
navigating this delicate balancing act. It's an internal tension, often
an emotional one.
Speaker 1 (47:05):
For retirees, the tension between.
Speaker 2 (47:07):
What between the natural desire for the highest possible income
right now, that big satisfying dividend check hitting your account today.
Speaker 1 (47:14):
Right maximizing current cash flow.
Speaker 2 (47:16):
Versus the less immediately gratifying but absolutely essential discipline of
prioritizing long term sustainability, and that means prioritizing dividend growth,
the inflation hedge exactly. The highest yield today might feel
the best in the short term, but the discipline focus
on ensuring your income stream grows over time is what
ultimately defines a successful dividend retirement plan that can comfortably
(47:39):
last thirty, forty or even more years. It's about future
purchasing power, not just the current paycheck size.
Speaker 1 (47:45):
So the final thought for our listeners as they consider
this path.
Speaker 2 (47:48):
The really critical question you need to ask yourself is
where does your personal situation, your timeline, your comfort with risk,
your need for income versus growth place you on that spectrum.
How will you balance the need for income to day
with the necessity of growth for tomorrow to land safely
within that sustainable three four percent withdrawal sweet spot. Mulling
over that balance is the real starting point for mapping
(48:09):
out your own dividend journey
Welcome back to the deep dive. We're here to cut
through the noise on complex planning topics. That's the mission,
and today we've got a really important one. We've gathered
a stack of research and.
Speaker 2 (00:10):
We're going deep, deep into structuring retirement entirely around investment income.
Speaker 1 (00:17):
Specifically zeroing in on the dividend retirement plan. That's our
focus exactly.
Speaker 2 (00:22):
You know, for a lot of listeners, the endgame isn't
just saving up.
Speaker 1 (00:25):
A pile of cash, right, It's more fundamental.
Speaker 2 (00:28):
It's about making that shift, that transition from being a
worker earning a salary to becoming well a portfolio owner
who's collecting income from those assets like collecting rent okay.
Speaker 1 (00:42):
And our goal today is to pull out the blueprint
for using those dividend payments, those regular payouts as your
main source of funds when you.
Speaker 2 (00:49):
Retire, the definitive strategy.
Speaker 1 (00:51):
So let's start with the basics, make sure we're all
on the same page. What exactly are dividends A.
Speaker 2 (00:55):
Good place to start. Dividends are simply payments that establish
companies make to their shareholders.
Speaker 1 (01:00):
Be people who own the stock.
Speaker 2 (01:02):
Right. It's usually quarterly and it's basically a share of
the company's profits being distributed.
Speaker 1 (01:07):
So you're literally getting a slice of the earnings just
because you own a piece of the.
Speaker 2 (01:11):
Company precisely, and that idea returning profit to the owners.
That's the bedrock of this whole retirement strategy.
Speaker 1 (01:19):
Okay, so the big picture here, the ultimate aim for
someone retiring this way.
Speaker 2 (01:24):
It's about security. It's securing a steady and ideally very
predictable income stream.
Speaker 1 (01:31):
One that can maybe supplement Social Security or a pension.
Speaker 2 (01:34):
Or even replace them entirely depending on the portfolio size.
When you structure it correctly, this approach can really deliver
financial stability. It offers genuine peace of.
Speaker 1 (01:44):
Mind because the cash flow is being generated, not just sent.
Speaker 2 (01:48):
Down exactly, generated not liquidated. That's a key distinction.
Speaker 1 (01:51):
I think that concept generated cash flow. That's really the
core appeal, isn't it. It's like the engine keeps running
without draining the fuel tank. We'll put Okay, let's dive
into section one them the core appeal. Why focus on
dividends for retirement? What makes them particularly suitable maybe compared
to other ways of getting income.
Speaker 2 (02:09):
Well, the number one benefit, the one you can't really
argue with, is creating a truly passive income stream passive
meaning meaning once you've done the upfront work, the research,
setting up the portfolio strategically, those dividend payments just.
Speaker 1 (02:24):
Show up like clockwork, hopefully.
Speaker 2 (02:27):
Often automatically deposited right into your account. It requires very
little ongoing effort compared to say, managing rental properties or
working part.
Speaker 1 (02:35):
Time, so the income is largely detached from your daily
time and effort.
Speaker 2 (02:39):
That's the ultimate goal, isn't it Income that doesn't depend
on your labor or trying to time the market perfectly.
Speaker 1 (02:44):
That definitely sounds appealing. But you know, the big worry
for retirees, the one that keeps people up at night,
is running out of money. Longevity risks absolutely. That usually
involves selling off your investments bit by bit, year after year.
How does a dividend strategy change that whole risk picture.
Speaker 2 (03:00):
It fundamentally shifts the focus. The goal becomes principal preservation.
Speaker 1 (03:05):
Protecting the original investment amount.
Speaker 2 (03:07):
Yes, and that's the huge strategic advantage here. Dividends are
paid from the company's profits, okay, which means they can
be distributed regularly without forcing you to sell the underlying
stock the asset itself.
Speaker 1 (03:20):
So the money machine stays intact.
Speaker 2 (03:22):
Exactly your initial capital, your principle. It stays invested, It
can continue to work for you, potentially grow over time,
and really importantly, it remains available for the long term
for unexpected future costs or maybe for leaving an.
Speaker 1 (03:37):
Inheritance, So it potentially sidesteps some of the anxiety around
that classic four percent withdrawal rule where you have to
sell no matter what the market's doing.
Speaker 2 (03:46):
Precisely, think about the contrast with say, managing a bond
portfolio for income. With bonds, yeah, you get the interest payments,
the coupon payments, but eventually that bond.
Speaker 1 (03:56):
Matures, right, you get your money back.
Speaker 2 (03:57):
You get the full principal amount back and a lumps
and then immediately you've got this task, maybe even in
anxiety inducing.
Speaker 1 (04:04):
One, figuring out what to do with.
Speaker 2 (04:06):
It, where and how do you reinvest that chunk of
principle safely just to keep the income going. It's a
constant cycle.
Speaker 1 (04:13):
The dividend stock owner doesn't have that specific.
Speaker 2 (04:16):
Headache generally, no sure the company, assuming it stays healthy,
just keeps paying the dividend. Your principle stays invested in
the stock, hopefully growing along with the business over time
you bypass that constant reinvestment pressure.
Speaker 1 (04:29):
Yeah, that need to keep re risking your principle with
bonds is definitely a burden. And thinking about the types
of companies that pay reliable dividends, there's sort of an
inherent quality there isn't there.
Speaker 2 (04:42):
Absolutely, We're generally not talking about speculative growth stocks or
volatle tech startups here now. The focus is typically on stable,
high quality companies, often.
Speaker 1 (04:51):
Called blue chips household names.
Speaker 2 (04:53):
Right, organizations with long histories proven financial discipline, often in
industries that are less sensitive to economic.
Speaker 1 (05:00):
Cycles, like what sort of industries.
Speaker 2 (05:01):
The utilities, consumer staples that things people buy regardless of
the economy, or healthcare things people need exactly. Their long
term commitment, sometimes decades long, to paying dividends provides a
really critical buffer against market volatility.
Speaker 1 (05:16):
So even if the overall market takes a nosedive, well,
people still.
Speaker 2 (05:20):
Need electricity, they still buy groceries, they still need medicine. Right,
These companies, because the essential nature of what they do,
often have enough cash flow resilience to maintain their dividend
payments even during downturns.
Speaker 1 (05:33):
You might even increase them.
Speaker 2 (05:34):
Some do and that offers real predictability when other parts
of the market might be in panic mode.
Speaker 1 (05:40):
Okay, that addresses market stability, but what about inflation, that
quiet erosion of purchasing power. If my dividend income just
stays the same year after.
Speaker 2 (05:49):
Year, it's value shrinks.
Speaker 1 (05:51):
You're absolutely right, So how does this strategy tackle that?
Speaker 2 (05:55):
This is where the strategy gets more sophisticated. It's not
just about collecting dividends. It's about implementing an inflation defense. Wow,
through the concept of dividend growth. A dividend payment that
stays flat static ultimately fails the long term retirement.
Speaker 1 (06:10):
Dest because costs go up exactly.
Speaker 2 (06:13):
A successful dividend retirement plan demands that you look beyond
just the highest immediate yield. You need to focus on
companies that have a proven track record of increasing their
dividend payout year after year after year.
Speaker 1 (06:26):
That annual raise is the key.
Speaker 2 (06:28):
That increase is the inflation hedge. It's crucial.
Speaker 1 (06:32):
And the research gives us some good labels for identifying
companies with that kind of proven track record, doesn't it.
These categories show resilience.
Speaker 2 (06:39):
Yes, we look for specific groups. First, the dividend aristocrats aristocrats.
These are companies, typically in the S and P five
hundred index, that have successfully increased their dividend for twenty
five or more consecutive years.
Speaker 1 (06:52):
Twenty five years straight. Think about what that means.
Speaker 2 (06:55):
It means they raise their payout through the dot com crash,
they raise it through the two thousand and financial crisis,
they raise it through the recent pandemic.
Speaker 1 (07:03):
That speaks volumes about their management and their business model.
Speaker 2 (07:06):
It really does. And then you have the absolute gold standard,
the dividend.
Speaker 1 (07:10):
Kings even better than aristocrats.
Speaker 2 (07:13):
Fifty or more consecutive years of dividend increases fifty years.
Speaker 1 (07:18):
That's incredible.
Speaker 2 (07:20):
It's a stunning track record. It doesn't happen by chance.
It reflects things like market dominance, really efficient operations, pricing power.
Speaker 1 (07:27):
The ability to pass on rising costs right.
Speaker 2 (07:29):
All things needed to consistently generate rising profits to fund
those rising dividends.
Speaker 1 (07:35):
The sources mention some examples.
Speaker 2 (07:37):
Yeah. Classic examples often cited are companies like Procter and Gamble,
Coca Cola decades of consistent growth, and that.
Speaker 1 (07:44):
Growth is what ensures your income stream keeps pace or
even outpaces inflation.
Speaker 2 (07:50):
Which is absolutely non negotiable. If your plan needs to
last thirty maybe forty years, your purchasing power must be protected.
Speaker 1 (07:58):
Okay, so the why is clear. Potential for financial freedom,
keeping your principle safe and fighting inflation through growth. Powerful combination,
it really is. But before anyone gets excited and starts
picking stocks, we need to build the foundation.
Speaker 2 (08:12):
Properly, absolutely critical.
Speaker 1 (08:13):
Let's move into section two. Building the foundation. This starts
with a really personal assessment, doesn't it.
Speaker 2 (08:19):
Step one is all about assessing your own financial needs,
and you have to be thorough here, no guessing.
Speaker 1 (08:26):
Determine exactly how much income you'll need in retirement, right.
Speaker 2 (08:30):
You hear rules of thumb like needing seventy percent or
eighty percent of your pre retirement income.
Speaker 1 (08:34):
Are those useful?
Speaker 2 (08:35):
You're a starting point maybe, But real planning needs a
detailed bottom up look at your expected expenses well kinns
of things everything anticipated health care costs which could be significant,
travel plans, hobbies, property taxes. Will your mortgage be paid
off or is that still a factor?
Speaker 1 (08:54):
You need specifics.
Speaker 2 (08:55):
You need specifics to get an accurate total annual expense number.
Speaker 1 (08:58):
Okay. Once you have that num, that total expense figure,
then comes the really crucial calculation.
Speaker 2 (09:05):
Yes, defining the income gap, Explain that you take your
total estimated annual expenses that you just calculated. Then you
subtract any income you already know. You'll have guaranteed income
like Social Security, so security, maybe a traditional pension, if
you're lucky enough to have one, perhaps payments from an
annuity you already own.
Speaker 1 (09:23):
Okay, expenses minus guaranteed income.
Speaker 2 (09:25):
That number left over that is your income gap. That's
the precise amount of money your dividend portfolio has to
generate for you reliably every single year.
Speaker 1 (09:35):
That's the target. But when you're figuring out that target,
we need some reality checks. Inflation came up before. Let's
put some numbers on that risk. Planning based on today's
costs is dangerous.
Speaker 2 (09:45):
It's a fundamental flaw if you ignore it. Let's use
the example from the research. Assume a pretty moderate three
percent annual inflation rate.
Speaker 1 (09:53):
Okay, three percent seems reasonable.
Speaker 2 (09:55):
If you figure out you need forty thousand dollars a
year to cover your expenses today US ten years, assuming
that three percent inflation each year, that same forty thousand
dollars will only buy what about twenty nine eight hundred
dollars buys today.
Speaker 1 (10:09):
Wow, that's a huge drop. Look at twenty five percent
loss in purchasing power over just a decade.
Speaker 2 (10:13):
It really hammers home why you need income that grows?
Why give it? In growth stocks are so much more
suitable than investments with static yields.
Speaker 1 (10:20):
Okay, point taken on inflation. Next reality check taxes. Income
is income, but the IRS treats different kinds differently, right,
and that affects your net income massively.
Speaker 2 (10:30):
You absolutely must understand the tax applications from the very beginning.
Speaker 1 (10:34):
How do dividends get taxed?
Speaker 2 (10:36):
As we'll get into more detail later, they generally fall
into two main buckets. You've got qualified dividends. Qualified these
are typically taxed at the lower long term capital gains
rates could be zero percent, fifteen percent, maybe twenty percent
depending on your overall income, much better than regular income
tax rates. On the second bucket, ordinary dividends, These get
taxed at your regular much higher income tax rate, same
(10:59):
as your salary ouch.
Speaker 1 (11:01):
So knowing the difference is key.
Speaker 2 (11:03):
It's crucial for optimization, and this is where talking to
a tax advisor becomes really important. Deciding where to hold specific.
Speaker 1 (11:11):
Investments like in a tax advantaged account versus a regular
brokerage account.
Speaker 2 (11:15):
Exactly. Making the right choices there can literally save you
tens of thousands of dollars in taxes over a thirty
year retirement. It's not a minor.
Speaker 1 (11:23):
Detail, definitely not Okay. Before we get to the big
calculation the portfolio size needed, there's one more piece of
the foundation, the safety net, the.
Speaker 2 (11:32):
Cash reserve, your emergency fund. This is non negotiable, right,
absolutely non negotiable portfolio insurance. Essentially, the recommendation is typically
to hold enough cash to cover six to twelve months
of your essential living expenses.
Speaker 1 (11:46):
Why is that so critical, specifically for a dividend strategy, because.
Speaker 2 (11:51):
Even the stocks of the most stable divid and paying
companies can and do experience temporary price drops the market fluctuates. Right,
You never want to be in a position where you're
forced to sell your valuable dividend paying stocks, your principle,
just to cover an unexpected bill, especially if the market
happens to be down at that moment.
Speaker 1 (12:10):
Selling low the worst case scenario.
Speaker 2 (12:12):
Exactly that cash reserve prevents that, it prevents forced selling
during market downturns. It lets your income producing assets recover
untouched while you handle the emergency.
Speaker 1 (12:21):
Makes perfect sense. Okay, safety net in place. Now for
step three, calculating the required portfolio size. This is where
the dream meets the math.
Speaker 2 (12:31):
It's the moment of truth translating that income gap number
into the actual nest egg size you need to build.
Speaker 1 (12:36):
How do we do that?
Speaker 2 (12:37):
The formula itself is quite simple, but the inputs you
choose are really strategic. The basic formula is portfolio size
equals the annual dividend income needed.
Speaker 1 (12:46):
That's the income gap we calculated.
Speaker 2 (12:48):
Right, divided by the average dividend yield you expect your
portfolio to generate.
Speaker 1 (12:52):
Okay, let's use the concrete example from the research to
make this real. If someone determines their income gap is
forty thousand dollars a year.
Speaker 2 (12:59):
They need for dollars and dividends annually, and let's.
Speaker 1 (13:02):
Say we target an average portfolio yield of four percent.
That seems like a reasonable target based of what you
said earlier.
Speaker 2 (13:08):
It is. So you take forty thousand dollars and divide
it by four percent or point zero four.
Speaker 1 (13:12):
Okay, forty thousand dollars divided by point zero four that
equals one million dollars.
Speaker 2 (13:17):
Exactly to reliably generate forty thousand dollars a year from
dividends with a four percent average yield, you need a
portfolio principle of one million dollars.
Speaker 1 (13:25):
That million dollar number can feel daunting. Why stick to
that three four percent yield target? Why not try to
find stocks yielding six percent or eight percent to need
a smaller portfolio.
Speaker 2 (13:34):
That's a really important question. It comes down to risk
management and sustainability. If you start chasing significantly higher yields,
say consistently about five percent or six percent, you are
almost always taking on more risk. Risk of what the
risk that the dividend could be cut because the company
isn't actually earning enough to support it, or the risk
(13:56):
that the company itself isn't financially stable. And the high
yield is a sign of distress, not strength.
Speaker 1 (14:02):
So the yield is high because the stock prices fallen often.
Speaker 2 (14:05):
Yes, that three four percent target yield range is generally
seen as the sweet spot. It balances generating a decent
level of immediate income with ensuring the long term stability
and crucially, the potential for that dividend growth we talked about,
which requires healthy companies.
Speaker 1 (14:21):
Right, You need profits to dividends. Okay, that one million
dollar target or whatever the calculated number is. For listeners
still maybe ten twenty years away from retirement, seeing that
number really highlights something powerful.
Speaker 2 (14:31):
The incredible power of starting early.
Speaker 1 (14:34):
Compounding time is the magic ingredient.
Speaker 2 (14:36):
It's irreplaceable. The sources had a great illustration of this
someone investing ten thousand dollars per year assuming a seven
percent average annual return starting at age thirty and continuing
consistently until.
Speaker 1 (14:48):
Age sixty five, So thirty five years of investing ten
dollars k year.
Speaker 2 (14:53):
That consistent effort could grow the portfolio to over one
point two million dollars. Wow. If you wait, if you
start the same planet age forty five instead of thirty,
the final number is drastically lower. Time is the most
powerful component in compounding, even more than the amount you
invest each year.
Speaker 1 (15:11):
That's a huge motivator to start now, even if it's
small amounts. And for people still in that building phase,
that accumulation phase, there is a practical tip too.
Speaker 2 (15:20):
Yes, maximize your tax advantage accounts first.
Speaker 1 (15:22):
Your iras, your four oh one k's in the US
or similar accounts elsewhere.
Speaker 2 (15:26):
Exactly, it's about structural efficiency. If you can have your
dividends reinvested and grow without having taxes take a.
Speaker 1 (15:32):
Bite out of them meach year, they compound faster.
Speaker 2 (15:34):
Much faster. Imagine one hundred dollars dividend if it's reinvested
as one hundred dollars inside of tax advantaged to account
versus maybe only eighty five dollars after tax is in
a regular approkerage account. That difference adds up enormously over decades.
It helps you reach that target portfolio size much more
quickly and easily.
Speaker 1 (15:49):
Okay, great advice. So we know the why, We know
how to calculate the how much. Now let's get into
the whats Section three. Architecting the portfolio. What are the
building blocks we need to assemble this income machine.
Speaker 2 (16:03):
The absolute guiding principle here has to be diversification. Rigorous diversification.
Speaker 1 (16:09):
Don't put all your eggs in one basket.
Speaker 2 (16:10):
Or even one type of basket. Now, we're aiming to
build a portfolio that generates consistent income, yes, but also
minimizes the risk that any single stock failing or anyone
sector having a bad decade derails the whole plan.
Speaker 1 (16:24):
So the different parts need to work together as.
Speaker 2 (16:27):
A cohesive unit balancing stability, growth potential, and reasonably high
current yield.
Speaker 1 (16:32):
Let's start with the core component component one dividend stocks themselves.
When picking individual stocks, what are the must have criteria.
Speaker 2 (16:39):
You're looking for? Financial strength, resilience. Focus on those blue
chip stocks we mentioned earlier, primarily in stable, less cyclical industries.
Companies that are proven they can navigate economic downturns. Consumer
goods think packaged foods or household products, healthcare, pharmaceuticals, medical devices,
regulated utilities providing essential services.
Speaker 1 (16:59):
The sources mentioned specific names.
Speaker 2 (17:01):
Yeah, examples like Johnson and Johnson in healthcare, Pexico and
consumer staples. Maybe a telecom like AT and T. Companies
with huge scale, established brands, strong market positions.
Speaker 1 (17:13):
And we keep circling back to the yield. What's the
target range again? For individual stocks?
Speaker 2 (17:19):
We stick to that general two five percent sweet spot.
You have to be really, really cautious about chasing yields
much higher than that.
Speaker 1 (17:26):
Why the caution.
Speaker 2 (17:27):
An extremely high yield, say eight percent, ten percent or more,
is often a warning sign. It might mean the stocks
price is cratered because the market thinks the dividend is unsustainable.
Speaker 1 (17:36):
A yield trap.
Speaker 2 (17:37):
It can be or might mean the company is paying
out way too much of its earnings as dividends, leaving
nothing for reinvestment or weathering tough times. You need to
ensure the yield is backed by solid financial health, not
just market desperation.
Speaker 1 (17:50):
Okay, so how do we check that sustainability. You mentioned
a metric earlier, the payout ratio.
Speaker 2 (17:55):
Yes, the payout ratio. This is a crucial piece of
announce ulas is for any dividend investor. Listeners really need
to understand this one.
Speaker 1 (18:04):
Okay, break it down for us. How is it calculated?
Speaker 2 (18:07):
It's actually pretty simple math. You take the total dividends
the company pays per share over a year h and
you divide that by the company's earnings per share or
EPs over the same period.
Speaker 1 (18:19):
So dividends divide by earnings. What does that percentage tell you?
Speaker 2 (18:23):
It tells you exactly what proportion of the company's profits
are being returned to shareholders in the form of dividends.
Speaker 1 (18:29):
And what's a good range for that ratio? What are
we looking for?
Speaker 2 (18:32):
The sources generally suggest aiming for a payout ratio below sixty.
Speaker 1 (18:35):
Percent sixty percent or less. Why that level.
Speaker 2 (18:38):
Let's say a company earns two dollars per share and
pays out one dollar per share in dividends. That's a
fifty percent payout ratio. Okay, that means the company retains
the other fifty percent of its earnings. That retained cash
gives them a cushion. They can use it to handle
unexpected costs, pay down debt, invest in future growth projects.
Speaker 1 (18:56):
Or keep paying the dividend even if earnings dip slightly.
Speaker 2 (19:00):
It provides a safety margin. It suggests the current dividend
level is sustainable and maybe even has room to grow.
Speaker 1 (19:06):
What if the ratio is much higher, say eighty percent,
ninety percent, or even over one hundred percent.
Speaker 2 (19:11):
If it's consistently above eighty percent, management has very little
room for error. Any hiccup in earnings could threaten the dividend,
and over one hundred percent. If the put ratio is
over one hundred percent, it means the company is literally
paying out more in dividends than it's earning and profit.
That sounds bad. It's mathematically unsustainable in the long run.
It means they're funding the dividend by taking on debt,
(19:32):
selling assets, or dipping into pass savings. That is a
huge red flag. Signaling a dividend cut is likely just
around the corner. You generally want to avoid those stocks aggressively.
Speaker 1 (19:42):
Okay, avoid high ratios, What about very low ratios? Is
ten percent or twenty percent always good?
Speaker 2 (19:48):
Not necessarily. While a very low ratio certainly means the
current dividend is safe, if it's consistently extremely low, say
under twenty percent for mature company, it might sometimes indicate
a different issue, maybe inefficient appital allocation. If a company
is generating tons of profit but just hoarding cash instead
of reinvesting it effectively or returning more to.
Speaker 1 (20:08):
Shareholders, you might question management strategy, right.
Speaker 2 (20:12):
Is that the best use of the company's capital. So
we're looking for that balance ratio maybe forty sixty percent,
reflecting both shareholder friendliness and prudent financial management.
Speaker 1 (20:22):
That nuance is really important. Okay, So that's individual stocks.
But picking stocks is hard and carries risk component too.
Helps with that. Dividend ETFs and mutual.
Speaker 2 (20:32):
Funds, Yes, this is the shortcut to diversification and often
a much lower stress approach for many investors.
Speaker 1 (20:38):
How do they work?
Speaker 2 (20:39):
These funds pool money for many investors to buy a
large basket of dividend paying stocks, sometimes hundreds of.
Speaker 1 (20:45):
Them, so you own a tiny piece of many companies.
Speaker 2 (20:48):
Exactly, which dramatically reduces the impact if any single company
runs into trouble. If one stock in the ETF cuts
its dividend, the overall yield of the fund barely registers
the change. It smooths out the ride.
Speaker 1 (21:00):
And the sources highlighted some specific ETFs focusing on different goals.
Let's compare two big ones mentioned, VIG and SCHD. What's
the difference?
Speaker 2 (21:11):
This choice really depends on where you are in your
investing journey and what you're prioritizing. VIG that's the Vanguard
Dividend Appreciation.
Speaker 1 (21:19):
ETF appreciation so growth exactly.
Speaker 2 (21:22):
Its specific mandate is to focus on companies with a
strong history of increasing their dividends over time. It prioritizes
that growth potential, often more than the.
Speaker 1 (21:31):
Current yield, So the starting yield might be lower.
Speaker 2 (21:34):
Typically, yes, vig's yield might be closer to two percent,
maybe a bit less sometimes, but the idea is that
the dividends it pays out will grow faster over the
long term, offering better inflation protection maybe ten fifteen years
down the road.
Speaker 1 (21:47):
Who is VG best suited for.
Speaker 2 (21:49):
Probably someone who is still maybe five, ten or more
years away from retirement. They're focusing on building future purchasing power.
Speaker 1 (21:56):
Okay, Now, compare that to SDHD. The schwab Us Dividend equity.
Speaker 2 (22:00):
SCHD takes a different tack. It aims for more of
a balance between current high yield and dividend growth. Right
It screens for stocks based on fundamental strengths, but also
tends to have a higher overall dividend yield than VG
right now, maybe close to three point five percent, sometimes
even four percent.
Speaker 1 (22:17):
So more income today, more.
Speaker 2 (22:18):
Income today, which makes it potentially better suited for someone
who's already retired or very close to it and needs
that cash flow.
Speaker 1 (22:25):
Now, what's the tradeoff?
Speaker 2 (22:27):
The trade off is often that the growth rate of
sehd's dividends might be slightly slower over the very long
term compared to a pure growth focused fund like VIJ.
Speaker 1 (22:36):
So the choice forces you to be honest about your priorities.
Speaker 2 (22:39):
Absolutely, are you optimizing for income today leaning towards SEHD
or maximum purchasing power in the future leaning towards VIG.
There's no single right answer. It depends on your situation, very.
Speaker 1 (22:50):
Clear, Okay, moving to component three, which often timeps investors
with even higher yields real estate investment trusts or rates.
Speaker 2 (22:59):
Ah yes, Why do.
Speaker 1 (23:00):
These typically offer such high dividend yields sometimes four percent,
five percent, even up to eight percent or more.
Speaker 2 (23:05):
It comes down to their special tax structure read's own
income producing real estate office buildings, malls, apartments, warehouses, and
by law, to maintain their favorable tax status, they are
required to distribute at least ninety percent of their taxable
income back to shareholders as dividends ninety percent minimum. This
structure allows the reed itself to avoid paying corporate income
(23:27):
tax on those distributed profits. But the result is that
huge amounts of cash flow directly to the investors the
shareholders as dividends.
Speaker 1 (23:36):
Sounds great, high yields, direct pass through of income. What
are the downsides or trade offs we need to be
aware of?
Speaker 2 (23:43):
There are a couple of key ones. First, re stock
prices can often be more volatile than traditional blue chip
dividend stocks. Why is that their valuations are closely tied
to the hell of the real estate market obviously, but
also very sensitive to changes in interest rates, which we'll
touch on more later.
Speaker 1 (23:58):
Okay, more volatility what else?
Speaker 2 (24:00):
Second, and this is really important for planning cats because
of how ret income is structured, it often includes things
like depreciation, pass throughs, or return of capital. The vast
majority of the dividends paid by reads are classified as
ordinary dividends.
Speaker 1 (24:14):
Not the favorable qualified dividends.
Speaker 2 (24:16):
Correct, they get taxed at your higher regular income tax rate.
So while they are fantastic cash flow generators, they can
be quite tax inefficient if you hold them in a
regular taxable brokerage account.
Speaker 1 (24:28):
So placement matters hugely for lates hugely.
Speaker 2 (24:32):
They are often prime candidates for tax sheltered accounts like
a roth IRA. More on that in the risk section.
Speaker 1 (24:38):
Okay, we have stocks, ETFs, reads. What's the final component
for stability? Component four? Bonds and fixed income?
Speaker 2 (24:47):
Right? We need some ballasts for the ship. Bonds or
other fixed income investments aren't primarily there to generate the
bulk of your income in this strategy.
Speaker 1 (24:54):
What is their role?
Speaker 2 (24:55):
Then? Their main function is stability capital preservation. They act
as shock ups or for the portfolio. How So, bonds
tend to be much less volatile than stocks or even reads.
They provide a source of reliable, low variance income and
help cushion the portfolio's value during stock market downturns.
Speaker 1 (25:12):
So if the stock market drops twenty percent.
Speaker 2 (25:14):
Your bond allocation should hold up much better, maybe even
gain value depending on the type, which helps stabilize the
overall portfolio value and provides funds for rebalancing or expenses
without selling stocks low.
Speaker 1 (25:26):
What kind of bonds we're talking about.
Speaker 2 (25:27):
Could be very safe options like US treasury bonds, maybe
tax advantage municipal bonds depending on your tax situation, or
diversified corporate bond funds that hold investment grade debt. The
key is their lower correlation to equities.
Speaker 1 (25:42):
Okay, bringing all these pieces together, stocks, ETFs, rates, bonds,
and what's the count? What's a reasonable starting point for allocation?
The sources suggested a model.
Speaker 2 (25:53):
Yes, a common balance structure recommended by advisors in the
materials is the sixty twenty twenty model.
Speaker 1 (25:57):
Sixty twenty twenty. What does that represent?
Speaker 2 (25:59):
It means sixty percent of the portfolio allocated to those
core dividend stocks and divid in ets. That's your engine
for growth and stable growing income.
Speaker 1 (26:07):
Okay, sixty percent in stocks.
Speaker 2 (26:08):
ATFS, then twenty percent allocated to reads. The slices there
specifically to boost the overall portfolio yield, taking advantage of
their higher payouts.
Speaker 1 (26:17):
Twenty percent ates yield, leaving.
Speaker 2 (26:19):
The final twenty percent allocated to bonds or potentially cash
equivalents like money market funds. This is your stability anchor,
the volatility dampener.
Speaker 1 (26:27):
Sixty percent stocks ATFS, twenty percent reads, twenty percent bonds
cash seems like a sensible mix.
Speaker 2 (26:33):
It provides good diversification across different asset classes, different sources
of income, varying risk profiles, and different sensitivities to economic
factors like interest rates. It's a solid starting.
Speaker 1 (26:43):
Template, a powerful template, indeed. But of course no plan
is without risk. We have to move beyond the ideal
setup and confront the real world challenges. Let's shift to
section four, navigating the trade offs and managing risks, because
even this well structured plan facestential headwinds.
Speaker 2 (27:00):
Absolutely. The first inescapable reality is market risk. Stock prices
go up and down. That's just inherent in owning.
Speaker 1 (27:07):
Equities, and even the best companies can fall on hard times.
Speaker 2 (27:10):
Exactly, even dividend aristocrats or kings can, in extreme circumstances,
be forced to cut their dividend if they face a
truly existential business crisis. It's not common for the best ones,
but it's possible.
Speaker 1 (27:21):
So knowing that risk exists, how does the careful dividend
investor actively mitigate it? Day to day year to year?
Speaker 2 (27:28):
Mitigation comes back to layering different types of diversification. First,
across sectors.
Speaker 1 (27:33):
Don't just own tech stocks, which is bank.
Speaker 2 (27:35):
Stock, right. You need exposure to healthcare, consumer staples, utilities, industrials, financials, energy,
et cetera. Spreading bets across the economy.
Speaker 1 (27:43):
And diversification across assets.
Speaker 2 (27:45):
Yes, using that mix we discussed stocks, ETFs, reets, bonds,
and within stocks owning a sufficient number of individual holdings.
If you're picking stocks yourself.
Speaker 1 (27:55):
How many is enough?
Speaker 2 (27:57):
The general guidance is often twenty to thirty individual stocks,
well diversified across sectors to significantly reduce single stock risk,
or much simpler, just use broadly diversified ETFs.
Speaker 1 (28:08):
And beyond diversification, active monitoring is key.
Speaker 2 (28:11):
You need to keep an eye on the underlying fundamentals
of the companies you own or the sectors your ETFs.
Focus on checking things like our earning still growing, is
the company taking on too much debt? Is that crucial
payout ratio staying within the save zone we talked about
below sixty seventy percent. Complacency is risky.
Speaker 1 (28:27):
Okay, Monitoring fundamentals mitigates company specific risk. Let's revisit inflation risk,
which you call the main long term threat. Remind us
how dividend growth is the specific antidote here.
Speaker 2 (28:39):
It bears repeating because it's so central. If your income
stream is flat, inflation will erode your purchasing power over time,
You'll be able to buy less and less each year.
Speaker 1 (28:49):
Dividend growth combats that directly.
Speaker 2 (28:51):
It's your primary defense within this strategy. Think about it.
If you own a stock yielding three percent today, but
the company reliably increases its dividend payment by say five
percent each year, your personal yield on your original investment
is actually increasing every year. That five percent growth in
the dividend payment is likely outpacing the long term average
(29:12):
inflation rate of maybe two three percent.
Speaker 1 (29:14):
Can we see the math on that?
Speaker 2 (29:15):
Sure, if you reinvest those growing dividends, that stock initially
yielding three percent with five percent annual dividend growth could
effectively be yielding closer to four point eight percent on
your original cost basis after about.
Speaker 1 (29:25):
Ten years, so your income stream is actively growing faster
than inflation.
Speaker 2 (29:29):
That's the goal. It ensures your retirement income maintains or
even increases its real purchasing power over decades. This is
why prioritizing companies with a history and capacity for future
dividend growth is often more important than just grabbing the
highest current yield you can find.
Speaker 1 (29:46):
That really underscores the discipline needed, especially for someone needing income.
Speaker 2 (29:50):
Now.
Speaker 1 (29:51):
It's tough to prioritize future growth over immediate cash flow.
Speaker 2 (29:54):
It is, but it's essential for long term success.
Speaker 1 (29:57):
Okay, Next, risk interest rates sensitive. This has been a
big topic recently. How do rising interest rates affect a
dividend portfolio?
Speaker 2 (30:05):
Rising rates change the relative attractiveness of different investments. When
interest rates go up significantly, like they have recently, safer
fixed income investments like CDs, money market accounts, or government
bonds start offering much more competitive yields than they did before. Okay,
Suddenly an investor might look at a dividend stock yielding
say four percent, which carries stock market risk, and compare
(30:26):
it to a virtually risk free treasury bill yielding five percent.
The T bill looks pretty.
Speaker 1 (30:32):
Good, So money flows out of dividend stocks, some of
it does.
Speaker 2 (30:35):
Yes, demand for dividend stocks can soften as investors shift
towards safer, now higher yielding alternatives. This can put downward
pressure on dividend stock prices, even if the companies themselves
are doing fine.
Speaker 1 (30:49):
And you mentioned earlier that reads are particularly vulnerable to
rate changes, why is that.
Speaker 2 (30:53):
Yeah, Reads often get hit with a double whammy when
rates rise. How So, First, their business model usually involves
borrowing money to buy and develop properties. When interest rates
go up, their borrowing costs increase directly. That squeezes their
profit margins.
Speaker 1 (31:08):
Makes sense. What's the second hit?
Speaker 2 (31:10):
Second, Because reads are primarily valued for their high dividend yields,
investors often view them as bond proxies or bond substitutes. Okay,
So when the yields on actual safer bonds rise significantly,
investors are very quick to sell their reed holdings and
move that money into the newly attractive bonds. This rapid
shift in capital flow can lead to sharper price drops
(31:31):
in the red sector compared to other dividend.
Speaker 1 (31:33):
Stocks, so be aware of that heightened sensitivity if you
hold reates. Finally, let's circle back and really nail down
the tax risk management piece. How do we strategically place
assets to minimize the tax bite?
Speaker 2 (31:47):
This is crucial for maximizing your spendable income. Remember the
two types of dividends first, qualified dividends.
Speaker 1 (31:55):
The ones tax at lower.
Speaker 2 (31:56):
Rates right, typically generated by holding common stocks of US
companies and some foreign ones for a sufficient period. Taxed
at those lower long term capital gains rates zero percent,
fifteen percent, or twenty percent.
Speaker 1 (32:09):
Where should these ideally be held?
Speaker 2 (32:11):
Because those tax rates are already relatively low. The common
advice is often to hold these types of stocks or
ETFs that generate primarily qualified dividends in your regular taxable
brokerage accounts. You get the benefit of the lower.
Speaker 1 (32:23):
Rate directly okay, qualified dividends and taxable accounts.
Speaker 2 (32:26):
That leaves the other kind, ordinary dividends. These are the
ones tax at your higher ordinary income tax rates.
Speaker 1 (32:30):
Just like salary which investments generate these mostly primarily.
Speaker 2 (32:34):
Reads as we discussed, also interest from most bonds and
bond funds and distributions from certain other paths through entities
like master limited partnerships MLPs.
Speaker 1 (32:43):
Where do these belong?
Speaker 2 (32:44):
These are the perfect candidates for your tax advantaged accounts,
especially WROTH accounts like a ROTH IRA or WROTH four
one K if possible.
Speaker 1 (32:52):
Why Roth specifically.
Speaker 2 (32:54):
Because with a WROTH, qualified withdrawals and retirement are completely
tax free. By holding your high yielding reds or bond
funds inside WROTH, you effectively eliminate the tax drag on
that income altogether. That five percent or six percent yield
from a RED actually becomes five percent or six percent
spendable income instead of being reduced by maybe twenty two percent,
twenty four percent or more in tax is if held taxable.
Speaker 1 (33:16):
So qualified dividends taxable account ordinary dividends like responds tax
advantaged account ideally wrong.
Speaker 2 (33:22):
That strategic placement is a key optimization lever in this
whole plan. It makes a real difference to your bottom line.
Speaker 1 (33:27):
Excellent clarification. Okay, we've built a portfolio. We understand the
risks and how to mitigate them. Now for the payoff.
Let's move smoothly into section five implementation withdrawal and maintenance.
We're officially retiring and turning on the income tap.
Speaker 2 (33:44):
Right, the focus shifts from building the asset base to
actually using it to live on. This starts with deciding
on your withdrawal strategy.
Speaker 1 (33:52):
What's the simplest, Maybe the ideal approach.
Speaker 2 (33:55):
The simplest and arguably the most sustainable. If your portfolio
is large enough, is the dividend only withdrawal.
Speaker 1 (34:01):
Strategy sounds straightforward? What does it mean?
Speaker 2 (34:04):
It means exactly what it sounds like. You live only
on the dividend income generated by the portfolio. You don't
touch the underlying principle at.
Speaker 1 (34:11):
All, So the original shares or fund units remain untouched.
Speaker 2 (34:15):
Great, the dividends get paid into your account, You withdraw
that cash to cover your expenses, and the principle remains invested,
hopefully continuing to grow and generate more dividends over time.
Speaker 1 (34:25):
When does this work best?
Speaker 2 (34:27):
It works perfectly if the natural yield of your portfolio
is high enough to cover your entire income gap. Using
our earlier example, if you need fifty thousand dollars a
year and your one point twenty five million dollar portfolio
happens to yield exactly four percent, generating fifty thousand dollars
in dividends, you just spend the dividends. Your principle never
(34:48):
has to shrink. That's the ideal sustainability model.
Speaker 1 (34:51):
But what if there's a shortfall. What if the dividends
don't quite cover all the expenses, or maybe the market
has a rough year and some companies freeze dividends.
Speaker 2 (34:59):
That's a common scenario. In that case, you'd likely shift
to more of a total return approach, or what we
can call supplementing.
Speaker 1 (35:05):
How does that work?
Speaker 2 (35:06):
You take all the dividend income you receive, and then
you cover the remaining expense shortfall by selling a small
calculated portion of your portfolio's.
Speaker 1 (35:13):
Principle, selling some shares or fund units.
Speaker 2 (35:16):
Right, maybe you need to sell just one percent or
perhaps two percent of your total portfolio value each year
to bridge that gap between the dividends received and your
total spending needs.
Speaker 1 (35:25):
Is that risky?
Speaker 2 (35:26):
It has to be done very carefully and deliberately. The
goal is still to preserve the vast majority of the
principle over the long term. If your income gap is
relatively small compared to your portfolio size, selling one two
percent a year is generally considered quite sustainable.
Speaker 1 (35:41):
But if you find yourself needing to sell, say six
percent or seven percent of your principle each year on
top of dividends, then you likely have.
Speaker 2 (35:48):
A structural issue. Either your expenses are too high or
your portfolio isn't large enough that rate of withdrawal significantly
increases the risk of running out of money.
Speaker 1 (35:57):
Which brings us neatly to that famous benchmark for sustainable
draws from any kind of retirement portfolio, dividend focused or not,
the Safe withdrawal rate or SWR.
Speaker 2 (36:07):
Yes, the SWR concept is absolutely fundamental here, regardless of
whether your income comes purely from dividends or a mix
of dividends and principal sales.
Speaker 1 (36:16):
What is that generally accepted SWR range.
Speaker 2 (36:19):
It's typically defined as withdrawing around three percent to four
percent of your portfolio's initial value in your first year
of retirement, and then adjusting that dollar amount upward for
inflation each subsequent year.
Speaker 1 (36:30):
Where does that three four percent number come from? Is
it just a guess?
Speaker 2 (36:33):
Not at all. It's based on extensive historical research and
financial modeling. The most famous piece of research is probably
the Trinity Study conducted by orte three finance professors at
Trinity University back in the nineties, though it's been updated
and replicated many times since.
Speaker 1 (36:48):
And what did the Trinity study find regarding that four
percent rate? Which is often cited.
Speaker 2 (36:53):
They analyze decades of historical US stock and bond market
returns and inflation rates. They ran simulations testing different withdrawal
rates over typical retirement periods, usually thirty years.
Speaker 1 (37:05):
What was the conclusion.
Speaker 2 (37:06):
They found that withdrawing four percent of the initial portfolio
value and then adjusting that dollar amount for inflation each
year had a very high probability of success, meaning the
portfolio is highly likely to last for at least thirty years,
even if retirement started right before a major market crash.
Speaker 1 (37:22):
Like ninety five percent success rate or higher in many scenarios.
Speaker 2 (37:26):
Exactly so for the dividend investor, whether you're living off
dividends alone or supplementing by selling principle, keeping your total
withdrawal dividends plus principal sales within that three four percent
as WR zone is the critical boundary. It's the key
to long term income sustainability versus risking premature depletion of
your funds.
Speaker 1 (37:47):
So that three four percent figure is really the guardrail
for the whole plan. Okay, withdrawal strategy set, but retirement
isn't set it and forget it right. There's ongoing work needed.
Speaker 2 (37:58):
Absolutely. Step six and seven are all about out continuous discipline, monitoring,
and maintenance. This isn't a one time setup.
Speaker 1 (38:04):
What does that involve? Annually?
Speaker 2 (38:05):
At least once a year. You need to sit down
and review and rebalance, look at how your investments have performed.
Speaker 1 (38:10):
Check on those fundamentals again.
Speaker 2 (38:12):
Yes, identify any holdings that are consistently underperforming or critically
any company that has cut its dividend. A dividend cut
is almost always a strong signal to reconsider holding that stock.
It indicates potential financial distress.
Speaker 1 (38:25):
So sell the cutters generally.
Speaker 2 (38:27):
Yes, replace them with stronger candidates. And rebalancing means adjusting
your allocations back to.
Speaker 1 (38:32):
Your target back to that sixty twenty twenty.
Speaker 2 (38:34):
For example, right if your stock's had a great year
and now represent seventy percent of your portfolio, well bonds
are down to ten percent. Rebalancing means selling some of
those appreciated stocks and buying more bonds to get back
to your sixty twenty target mix. This forces you to
sell high and buy low, and it manages.
Speaker 1 (38:50):
Risk and staying informed. Generally, you have to keep abreast.
Speaker 2 (38:53):
Of the bigger picture, monitor economic trends where interest rates
might be heading overall corporate earning's health. Being informed helps
you anticipate potential risks or opportunities.
Speaker 1 (39:04):
And one last piece of planning, especially if leaving money
to errors is important.
Speaker 2 (39:08):
Estate planning becomes relevant. If preserving that dividend paying principle
for the next generation is a key goal, you need
to consider things like setting up trusts or planning how
shares might be gifted efficiently over time. Integrating the dividend
plan with your estate plan is crucial for legacy goals.
Speaker 1 (39:24):
That makes sense. Okay, we've covered a lot of ground,
from theory to practical steps to really cement all this,
let's walk through the hypothetical case study from the sources
Jane's plan. This brings it all together.
Speaker 2 (39:35):
Great idea. Jane is fifty five years old and she's
planning to retire in ten years at age sixty five.
Speaker 1 (39:41):
Okay, what are her income needs?
Speaker 2 (39:43):
She's done her homework and calculates she'll need a total
annual income of sixty five thousand dollars to live comfortably
in retirement.
Speaker 1 (39:49):
Sixty five thousand dollars total. Does she have any other
income sources?
Speaker 2 (39:53):
Yes, she expects to receive about fifteen thousand dollars per
year from social Security.
Speaker 1 (39:57):
Okay, so sixty five thousand dollars needed min fifteen thousand
dollars from social Security. That leaves her income gap.
Speaker 2 (40:03):
Her income gap. The amount her portfolio needs to generate
is fifty thousand dollars per year.
Speaker 1 (40:08):
Fifty thousand dollars annually from dividends and door withdrawals. If
she targets that four percent average, you'll be discussed what's
her ultimate portfolio size? Goal?
Speaker 2 (40:16):
To generate fifty thousand dollars a year at a four
percent yield fifty thousand dollars four, Jane needs a target
portfolio value of one million, two hundred and fifty thousand
dollars by the time she retires at sixty five.
Speaker 1 (40:26):
One point twenty five million dollars. That's her number. Where
is she now at age fifty five?
Speaker 2 (40:31):
She currently has six hundred thousand dollars invested Okay, six
hundred dollars.
Speaker 1 (40:34):
Now needs the dollar twenty five dollars and ten years.
Can she get there?
Speaker 2 (40:38):
The projection assuming she continues to save and achieves a
realistic seven percent average annual return with dividends reinvested during
these final ten accumulation years, huh huh, is that her
portfolio is expected to grow to approximately one million, hundred
ninety seven thousand dollars by age sixty.
Speaker 1 (40:52):
Five alum million hundred and ninety seven thousand dollars, So
really close to her dollar and twenty five hundred target,
but just a.
Speaker 2 (40:59):
Little bit short. Exactly, very close, but not quite there
based on projections.
Speaker 1 (41:02):
Now, let's look at how she plans to allocate the
one point one nine seven million dollar portfolio at retirement.
Using the model we discussed, she.
Speaker 2 (41:09):
Decides to adopt that diversified sixty twenty twenty approach. Okay,
so sixty percent seven hundred and eighteen thousand, two hundred
dollars goes into a mix of dividend growth and broader
dividend ETFs like maybe SHD, targeting an average yield of
around three point five percent from this sleeve.
Speaker 1 (41:23):
Sixty percent in ETFs than the reads.
Speaker 2 (41:26):
Twenty percent two hundred three doe thousand, four hundred dollars
goes into higher yielding reads, perhaps including names like realty income,
aiming for a higher yield of about five percent from
this portion.
Speaker 1 (41:34):
And the last twenty percent the.
Speaker 2 (41:36):
Final twenty percent two hundred and thirty nine thousand, four
hundred dollars goes into stable bond funds expected to yield
around two percent for safety instability.
Speaker 1 (41:42):
Okay, so she has those three buckets with different target yields.
If you blend those allocations and yields together, what's her
projected overall portfolio yield?
Speaker 2 (41:50):
When you calculate the weighted average point six zero three
point five percent plus point two zero five point zero
percent plus zero point two zero two point zero percent,
her total portfolio is expected to yield proximately three point
eight percent overall.
Speaker 1 (42:03):
Three point eight percent. Now, let's look at the income reality.
When she retires at sixty five, her portfolio is one million,
one hundred and ninety seven thousand dollars at a three
point eight percent yield. How much dividend income does that
generate annually?
Speaker 2 (42:15):
One million, one hundred ninety seven thousand dollars times point
zero three eight equals forty five thousand, four hundred eighty
six dollars per year in expected dividend income.
Speaker 1 (42:23):
Okay, forty five thousand, four hundred and eighty six dollars
from dividends.
Speaker 2 (42:26):
But wait, she needs fifty thousand dollars to cover her
income gap.
Speaker 1 (42:29):
Got it all. This is where the supplementing strategy comes
in perfectly and safely. She needs to cover that four thousand,
five hundred and fourteen dollars gap by selling a small
amount of principle each year.
Speaker 2 (42:37):
How much does she have to sell relative to her
total portfolio?
Speaker 1 (42:40):
This is the key point. Selling four thousand, five hundred
and fourteen dollars represents withdrawing only about point three eight
percent of her total one million, one hundred ninety seven
thousand dollars portfolio principle each year. Four thousand, five hundred
fourteen seven one million, one million, one hundred and ninety
seven thousand dollars point three eight percent.
Speaker 2 (42:56):
That's tiny, It's incredibly small. Her total withdrawal rate is
the three point eight percent from dividends plus LUs the
point three to eight percent from principal sales, for a
total of four point one eight percent, which is.
Speaker 1 (43:08):
Right around that four percent safe withdrawal rate threshold exactly.
Speaker 2 (43:11):
It's well within the sustainable range. This very small principle
withdrawal is highly unlikely to deplete her portfolio over a
long retirement.
Speaker 1 (43:19):
The plan works, and her risk management is built in too.
Speaker 2 (43:22):
Absolutely. Jane manages market risk by using diversified ETFs and
reeds covering maybe ten different economic sectors. She plans to
monitor payout ratios. She maintains a separate cash reserve of
fifty thousand dollars covering almost a year of her portfolio
withdrawals to avoid selling during downturns, and the tax planning. Crucially,
she plans to hold those higher yielding rates which generate
(43:44):
ordinary income insider roth IRA to maximize your tax efficiency.
Speaker 1 (43:48):
Just as we discussed, so, Jane's plan really puts all
the pieces together. It's a realistic, well structured example.
Speaker 2 (43:53):
It's a fantastic illustration of how all these concepts needs assessment,
portfolio calculation, diversification, yield targeting, withdrawal strategy, and risk management
come together in a workable retirement plan.
Speaker 1 (44:05):
Definitely clarifies the process. Okay, as we approach the end
of this deep dive, let's crystallize the absolute must dues
for anyone considering this strategy. What are the essential takeaways?
Speaker 2 (44:15):
Let's boil it down. First, you must accurately assess your
retirement income. Needs to define that crucial income gap. No
shortcuts there, got it. Step one, know your number. Second,
calculate the portfolio size required to fill that gap, using
a realistic sustainable average dividend yield target, probably in that
three four percent range.
Speaker 1 (44:35):
Step two, know your target portfolio size.
Speaker 2 (44:38):
Third, build a broadly diversified portfolio, cross stocks, ETFs, maybe reads,
and bonds. Critically prioritize companies with a history and capacity
for dividend growth to combat inflation over the long haul.
Don't just chase the highest current yield.
Speaker 1 (44:53):
Step three, build diversified, focus on.
Speaker 2 (44:55):
Growth, and finally, fourth, implement and stick to a conservative
withdrawal strategy. Keep your total withdrawals, whether just dividends or
dividends plus principle, within that sustainable three percent to four
percent safe withdrawal rate zone. Discipline is key.
Speaker 1 (45:09):
Assess needs, calculate size, build diversified with growth focus, stick
to SWR excellent summary. Now, what about the big mistakes,
the common pitfalls that trip people up and derail this
kind of plan.
Speaker 2 (45:22):
Number one is definitely chasing yield, getting seduced by stocks
or funds yielding six percent, eight percent, ten percent or
more without doing extremely thorough due diligence. There often yield traps,
high risk disguise as high return and prone to dividend cuts.
Speaker 1 (45:37):
Avoid the siren song of unsustainable yields. Pitfall number two.
Speaker 2 (45:40):
Lack of diversification. Concentrating too much risk in just a
handful of stocks, or maybe too heavily in a single
sector like tech or energy. One bad apple can spoil
the whole barrel if you're not diversified.
Speaker 1 (45:50):
Diversified, diversified, diversify.
Speaker 2 (45:52):
Pitfall number three ignoring inflation. This happens if you focus
only on current income and fail to prioritize dividend growth.
Your purchasing power will steadily decline over retirement. If your
income doesn't grow. You must build in that inflation protection
from day one.
Speaker 1 (46:08):
Focus on growth, not just today's yield. And the final pitfall.
Speaker 2 (46:13):
Overdrawing the portfolio. Getting complacent or panicked and consistently withdrawing
more than that four percent, maybe five percent or more
of your portfolio value each year. That drastically increases the
odds you'll run out of money too soon.
Speaker 1 (46:26):
Stick to the plan, avoid chasing yield, diversify, properly, prioritize growth,
and don't overdraw.
Speaker 2 (46:32):
Got it.
Speaker 1 (46:32):
Those are the big ones to watch out for.
Speaker 2 (46:34):
This has been incredibly thorough. We've gone from the basic
appeal of dividends all the way through to detailed implementation
and risk management. It really does offer a different perspective
on retirement funding, less about spending down savings, more about
collecting income from assets you own.
Speaker 1 (46:50):
It's a powerful mindset shift. And you know what's really
fascinating about this whole dividend retirement plan strategy.
Speaker 2 (46:55):
Is that it's true long term success really hinges on
navigating this delicate balancing act. It's an internal tension, often
an emotional one.
Speaker 1 (47:05):
For retirees, the tension between.
Speaker 2 (47:07):
What between the natural desire for the highest possible income
right now, that big satisfying dividend check hitting your account today.
Speaker 1 (47:14):
Right maximizing current cash flow.
Speaker 2 (47:16):
Versus the less immediately gratifying but absolutely essential discipline of
prioritizing long term sustainability, and that means prioritizing dividend growth,
the inflation hedge exactly. The highest yield today might feel
the best in the short term, but the discipline focus
on ensuring your income stream grows over time is what
ultimately defines a successful dividend retirement plan that can comfortably
(47:39):
last thirty, forty or even more years. It's about future
purchasing power, not just the current paycheck size.
Speaker 1 (47:45):
So the final thought for our listeners as they consider
this path.
Speaker 2 (47:48):
The really critical question you need to ask yourself is
where does your personal situation, your timeline, your comfort with risk,
your need for income versus growth place you on that spectrum.
How will you balance the need for income to day
with the necessity of growth for tomorrow to land safely
within that sustainable three four percent withdrawal sweet spot. Mulling
over that balance is the real starting point for mapping
(48:09):
out your own dividend journey
Popular Podcasts
On Purpose with Jay Shetty
I’m Jay Shetty host of On Purpose the worlds #1 Mental Health podcast and I’m so grateful you found us. I started this podcast 5 years ago to invite you into conversations and workshops that are designed to help make you happier, healthier and more healed. I believe that when you (yes you) feel seen, heard and understood you’re able to deal with relationship struggles, work challenges and life’s ups and downs with more ease and grace. I interview experts, celebrities, thought leaders and athletes so that we can grow our mindset, build better habits and uncover a side of them we’ve never seen before. New episodes every Monday and Friday. Your support means the world to me and I don’t take it for granted — click the follow button and leave a review to help us spread the love with On Purpose. I can’t wait for you to listen to your first or 500th episode!
Stuff You Should Know
If you've ever wanted to know about champagne, satanism, the Stonewall Uprising, chaos theory, LSD, El Nino, true crime and Rosa Parks, then look no further. Josh and Chuck have you covered.
Dateline NBC
Current and classic episodes, featuring compelling true-crime mysteries, powerful documentaries and in-depth investigations. Follow now to get the latest episodes of Dateline NBC completely free, or subscribe to Dateline Premium for ad-free listening and exclusive bonus content: DatelinePremium.com