Investment Thought—Why dividends matter. Part I

I cant tell you how many of my friends have said to me over the past six months I was going to retire next year but my 401K is down (fill in your number) percent; so I am now going to have to work for another (again, fill in your number) years.

There is a lesson here. And that lesson is that while over the long term, rising stock prices on average have provided a larger component of total equity return than dividend yield, you live in the short term. And in the short term, you cant spend the historical average rate of capital appreciation on stocks. If you try, you will negatively impact the rising stock price component of your portfolios total equity return.

I dont want to get too deep into the math; but think for a minute. Lets say that you had a $1,000,000 in October of 2007 and you thought that total rate of return was all that mattered. So you owned a lot of low yield and non dividend paying stocks and your portfolio yielded 1.5%. Lets also say that you were either withdrawing or expected to withdraw sometime in the next couple of years $50,000 annually ($15,000 from dividends, $35,000 from capital gains). Looking for your portfolio to produce a 5% annual income return for you to spend is not unreasonable.

But where are you in April of 2009? You likely now have a $500,000-$600,000 portfolio. But if you take $35,000 out of capital, you are now expecting your portfolio to produce an 8-10% ($50,000/$500,000 or $600,000) annual income for you to spend—something that you could go broke doing.

Now lets say that in 2007, you had the same $1,000,000 portfolio and you needed or expected to need in the next couple of years the same $50,000 annual income from your portfolio. But in this example, you structured your portfolio with dividend paying stocks and sufficient bonds so that it produced $50,000 annually. Now where would you be in 2009? Your portfolio is worth less; but your income hasnt been impacted. Indeed, if you owned stocks that raised their dividends every year, your income would grown between 2007 and 2009 and would be greater than $50,000.

That is why an investment strategy that focuses on creating a growing stream of income (versus an increasing Portfolio asset value) is a necessity for any investor who either now or in the future expects to use those funds to accomplish an objective—like retirement. In stock land, a growing stream of income only comes from one source—companies that raise their dividends consistently.

News on Stocks in Our Portfolios

A negative write up on Sherwin Williams (Dividend Growth Portfolio):

seekingalpha.com/article/130585-sherwin-williams-is-in-for-a-shellacking-barron-s