Dividend Investing Strategy For Individuals Like You And Me (2024)

Written by Robert Kovacs

As a dividend investor with less than 10 years before retirement, I must say I'm biased towards stocks with higher yields. I don't own any equities which yield less than 3.5%. Sam owns many such stocks, but he is 30 years younger than I am.

And, while he likes to think he'll retire at the same time as me, he still has the benefit of having time on his side.

The time you have between now and retirement should have important consequences on the types of stocks you invest in. The structure of your cash flows also has an important impact.

Individual investors have different needs than professional investors. You and I are investing for retirement. Either to complement retirement pensions, or to cover all expenses. Professional money managers invest for next year's management and performance fee.

In fact, we're not even playing the same game. Our incentives are different, our cash flows are different, our timelines are different. And, this comes with many implications.

It's a totally different paradigm. Dividend investing introduces more complexities to this shift, since dividend investors expect the dividends their portfolio generates to cover their retirement expenses.

This is an honorable goal, and it is mine as it is Sam's. But it comes with many ramifications which strongly influence which stocks he invests in, and which I invest in. For example, Tyson Foods (TSN) makes sense for Sam. For me, not so much.

How should dividend investors approach stock selection? What factors should be considered? Those are the elements which will be considered in this article. My hope is that this article will help you structure your portfolio in such a way that you will live your golden years with a golden bank account.

To illustrate this, we'll run two simulations. As dividend investors, we can be defined by 4 variables:

• How much money we have.
• How much money we can save each month.
• How much money we want from dividends when we retire.
• When we want to retire and live off dividends.

This reflects how most humans live. We have some liquid assets which come from past savings. We also usually trade our work against income. Part of this is saved and invested each month. We also have a certain lifestyle and needs which will need to be covered by dividends when we stop working. Finally, there is a day when we will retire.

Scenario 1: 10 years before retirement

A 50-year old investor who:

• wants to retire in 10 years,
• has $500,0000 of liquid investable assets,
• can invest an additional $1,000 per month,
• and will need $4,000 per month once he retires.

Now, he can invest in dividend stocks which have the dividend yield of his choice, but for him to meet his goals, these dividend stocks will have to grow the dividend at different rates. Let's look at stocks with yields of 2%, 4%, and 6%.

To meet his target of $4,000 per month (which I adjust for 2% inflation), his dividend investments would have to grow at the following rates:

• 18.5% per annum if invested in stocks which yield 2%
• 7.2% per annum for stocks which yield 4%
• 0.1% per annum for stocks which yield 6%

Source: mad-dividends.com

You can see the obvious trade-off: required dividend yield and required dividend growth are negatively correlated.

Are there stocks which yield 2% and can grow their dividend by 18% for the next 10 years? Sure, there are a few.

But dividend growth is fleeting and highly dependent on management's discretion. It doesn't take much for a dividend to freeze. One big acquisition, one swift change in market environment, one new competitor looking to displace the incumbent, and all of a sudden, your dividends are frozen.

On the other hand, investing in dividend stocks which yield 6% or more requires virtually no dividend growth. A much more conservative proposition if you ask me, since the dividend investor only needs to assess the dividend's safety to meet his goals.

Should such an investor only buy high yield stocks? Of course, not. He can focus on stocks with lower yields, if he believes the growth targets will be met. But this information should at least tilt him towards higher yielding stocks.

When I ran such a simulation for my personal situation, I decided the reasonable thing to do was to invest in stocks which yielded at least 3.5%

You can run such simulations for free with the simulator included on the following page.

Scenario 2: 40 years before retirement

Now, let's consider an investor with a different profile.

He is farther from retirement, but also has less cash and savings power, but expects a similar lifestyle.

He is a 25-year old investor who:

• wants to retire in 40 years,
• has $50,0000 in liquid investable assets,
• can invest an additional $750 per month,
• and will need $4,000 per month once he retires.

The first thing to note is that 2% inflation has large impacts on that $4,000 over 40 years. $4,000 today would be worth more than $8,000 in 40 years.

The second thing to note is that he doesn't need nearly as much dividend growth because he has time on his side. He would need the following dividend growth:

• 7.8% per annum if invested in stocks which yield 2%
• 3.4% per annum for stocks which yield 4%
• 0.1% per annum for stocks which yield 6%

Source: mad-dividends.com

Now, do you think any half-skilled dividend investor can identify stocks which yield 2% and grow the dividend at 8% per year? Most definitely, although it is unlikely that he will achieve this by buying and keeping the same stocks for 40 years. He will have to monitor his portfolio and move into the most attractive dividend stocks at any time.

He can invest in higher yielding stocks as well, but doesn't need to focus on them, and should even make them a smaller part of his portfolio. Maybe as little as 10 to 20%. The rationale is that stocks which grow their dividend at a fast rate in a sustainable manner usually increase in price over time.

Even when investors do these sorts of calculations which focus solely on dividends, total returns can't be forgotten.

Dividend investors shouldn't disregard total returns, they should simply decide to pick stocks where the dividend will contribute significantly to total returns.

But capital gains can't be dismissed, especially for individuals who have 20, 30, or even 40 years before retirement. If you buy a stock which yields 2% and the price doubles, that capital gain - if realized - is worth 50 years of dividends. Selling the stock and buying a new 2% yielder would instantly double your income.

So, such an investor should focus mainly on stocks with the potential to aggressively grow their dividend, even if they have lower yields. This is the best route to not only meeting his goals, but even beating them, which will then allow him to either: retire earlier or have even more money in retirement.

Key takeaways

There is a reason it's called personal finance. It's a personal affair and should be catered to your particular situation. When approaching dividend investing, keep that in mind. You can run similar simulations to those presented in this article, with your personal situation here.

When you read recommendations on Seeking Alpha, keep in mind who is writing the article. I write on stocks which yield 3.5% and up, while Sam writes on those below that threshold. This isn't a coincidence, since the stocks which a 25-year-old should consider are different than those a 55-year-old should consider.

The more time you have between now and retirement, the more you can focus on stocks with lower dividend yields.

This is also true of the 3 other variables which define you as a dividend investor:

• The more cash you have… (surprise)… the more you can focus on stocks with lower yields.
• The more you can save each month, the more you can focus on stocks with lower yields.
• Lower retirement spending will also allow you to focus on lower dividend yields.

Don't approach dividend investing blindly. If you don't have a proper benchmark to track your progress against, you'll pick stocks which don't meet your needs.

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