One reason that saving for retirement seems, well, Sisyphean, is the enormous amounts of money that financial services companies tell us we must save — typically, 10% to 12% of our income, starting with our first job and ending with our perpetually postponed retirement date.
And there's good reason for saving a great deal for retirement, the primary one being that inflation will force you to take ever-larger withdrawals from your account. You can combat that problem with dividend-paying stocks: But here, too, it pays to start early.
Last week, we looked at the plight of Ralph Btzflk, the luckless retiree who started taking withdrawals from stocks just as the second-worst bear market in history began in March 2000. Ralph discovered that taking withdrawals from stocks in a bear market sends your balances tumbling downhill.
But Ralph had an additional problem, aside from timing: inflation.
Ralph had decided to withdraw $50,000 a year — the amount he figured he'd need for a comfortable retirement. But each year, Ralph's $50,000 would have a little less spending power, because of inflation. Even though inflation averaged 2.22% a year for the period, the effects of inflation are cumulative. By last March, Ralph's $50,000 withdrawal would have had the buying power of $31,000. In 2000 dollars.
Sooner or later, Ralph would have to increase his withdrawals to account for inflation, and that would deplete his retirement savings even faster. Because of inflation, financial planners typically recommend that your initial withdrawal be 4% of your retirement savings, assuming you intend to adjust your withdrawals every year for inflation.
Starting with such a low withdrawa! l rate will probably keep your retirement kitty purring through your 90s or longer. The problem, of course, is that it's a low withdrawal rate. To get $50,000 in income, you'll need to start with $1.25 million.
You can offset the effects of inflation in several ways. Several readers suggested cutting your spending, which is far easier to suggest to other people than to do yourself. And you can add some inflation-fighting investments to your portfolio, such as Treasury Inflation-Protected Securities, or TIPS, which rise in value in lockstep with the consumer price index, the government's main gauge of inflation.
But TIPS pay precious little in income, which is what most retirees are seeking. In fact, most things that retirees traditionally relied upon — money funds, bank CDs, Treasury securities, corporate bonds — pay relatively little in interest. (To get $50,000 in income from the average money fund these days, you'd need to start with $500 million.)
And this is why we come to dividend-paying stocks. Dividends are cash payouts from companies to shareholders. Currently, the average dividend yield of the Standard and Poor's 500 -stock index is 2.1%. This may not seem like much, but the S&P 500 without dividends would have turned $10,000 into $42,000 in 20 years. With dividends: $61,700.
The best part about dividends is that companies can — and do — increase them regularly. You may love your corporate bond to death, but you'll never get a boost in interest from it.
Standard and Poor's keeps a list of companies that have increased their dividend yields every year for the past 25 years — the Dividend Aristocrats. Companies that boost dividends consistently tend to have good financial strength. Wall Street likes a dividend cut about as much as it likes a cigar box packed with bees. Companies that increase their dividends, then, are tacitly saying that they don't plan to reduce those dividends.
One problem with the Aristocrats is that their yields aren't neces! sarily th! at high. If you're planning a permanent dividend hike, you want to make sure you won't raise the bar too high. So an Aristocrat such as Walgreen's has a 1.81% yield, and another Aristocrat like Johnson & Johnson has a 2.63% yield.
The ProShares S&P 500 Aristocrats ETF (ticker: NOBL), tracks the S&P Dividend Aristocrats index. It's too new to have a 12-month yield. But Vanguard's Dividend Appreciation Index ETF (VIG) follows the Nasdaq's dividend Achievers index, which requires a 10-year record of raising dividends. Yield: 1.9%.
Using a 10-year dividend record is fine, says Todd Rosenbluth, director of ETF research for S&P Capital IQ. "Anything that covers 2007-2009, when dividend cuts were popular, is good," he says. Companies that could raise their dividends through the worst bear market since the Great Depression are not only financially strong, but shareholder-friendly.
If you want higher yields, you might consider ETFs that follow the High Yield Aristocrats. These are the 50 or so companies in the broad-based S&P 1500 index that have raised their dividends for more than two decades. The SPDR Dividend ETF (SDY) tracks that index. Unlike Vanguard's offering, the SPDR Dividend ETF has a greater number of financial services stocks, particularly real estate investment trusts, Rosenbluth says.
Another favorite: Schwab Dividend Equity ETF (SCHD). While it has little exposure to financial stocks, it does have exposure to sectors that would benefit from a broad-based economic recovery, such as industrials and even technology, where dividends are becoming increasingly popular.
You should avoid companies with excessively high dividend yields. Companies don't offer fat yields because they're swell people who want to spread the wealth around. A dividend yield is the payout divided by the stock price. Most likely, companies with high dividend yields haven't hiked the payout: They have seen their stock price fall. In the most likely scenario, they will cut their di! vidend to! save money.
Dividends are just one part of a retirement investment strategy, but they're a key one. They won't entirely shield you from investing at the wrong time, or from inflation — but they'll help.
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