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I've been startled recently by news stories about the massive declines in endowments at elite universities such as Harvard, Yale, Stanford, and Princeton. Sure, many investors lost money over the past year, but the performance at Harvard and Yale "badly trailed" the results at the average college, as The Wall Street Journal so delicately put it. I'm shocked, but not because of these endowments' lackluster performance.

With exotic strategies and illiquid investments, the endowments racked up the following investment losses in their latest fiscal year:

• Harvard: 27%
• Columbia: 16%
• Princeton: 24%
• MIT: 17%
• Cornell: 26%
• Brown: 23%

Those losses compare to the 18% drop for the median large endowment.

Well, so what?
The market has been a beast to investors over the past year, and I'm not faulting investment decisions here. The shocking part to me is that the capital of these endowments is used to fund operational expenses at many such institutions. This means that investment managers have to turn a profit, lest the schools cut their capital expenditure budgets (or cut in even more pressing areas, such as salaries).

The investment losses have forced Yale to take action. It's already projecting annual budget deficits of $150 million for the 2010-2011 academic year to the 2013-2014 year. Last winter, it cut staff and nonsalary expenses and indicated that the administration would ask for more cuts.

Princeton is in a similar boat. It's mimicking the moves that many consumers are making as their investment returns dry up -- cutting its budget and borrowing money -- because it doesn't want to sell when the market could improve.

But why depend on capital gains?
Increasing their capital gains was one of these schools' primary means of getting the money to fund their budgets. And as you're no doubt aware, the market doesn't always go up, making such a strategy fraught with danger.

What if you buy in at the wrong price? Because you need the money, you have to sell at whatever the market will offer you. Such a short-term mentality can ruin you. If you had purchased Citigroup at around $25 in April 2008, it seemed you were getting a great deal. The stock was down more than 50% from its five-year highs. Regardless, over the course of the year, the stock bottomed at $0.97, and still has not returned to anywhere close to $25.

If you have to sell Citigroup at $1 in order to pay your mortgage (or your professors' salaries), you have to sell it. The same pattern holds true for a variety of other formerly high-priced financials such as AIG (NYSE: AIG) and Fannie Mae (NYSE: FNM).

Rather than relying on capital gains to sustain our budgets, we need the power of ever-increasing dividend streams. With such a strategy, you -- unlike Princeton -- will never have to float debt in order to avoid whittling down your principal. Think of it as a third income.

A third income?
This investing debacle suggests why individual investors should look to strong dividend-paying companies that increase their payouts over time.

My vision for retirement is to rely exclusively on dividend income. Sure, Uncle Sam may chip in his two bits, but my wife and I will depend on the steady stream of income provided by some of the world's most profitable companies. By relying on steady dividend income from a diversified portfolio of blue-chip companies, you'll never have to worry about declining stock prices. On the contrary, massive market downturns become a great opportunity to buy into even bigger dividend streams, as stock prices crater and yields soar.

The only downside to this strategy is that you need to have a long-term horizon. But when the dividend dynamo starts really working, you feel the anticipation of getting a sizable dividend check every three months. And unlike fluctuating interest rates, which have killed those who recently invested in CDs, dividend-paying companies tend to increase their payouts year after year -- despite the rare series of reductions we recently experienced.

In fact, it's not unusual for the best companies to increase their payouts from 7%-10% per year. I like a 10% raise every year, especially in retirement. And there are plenty of safe investments whose solid yields have been growing much faster:

Data from Capital IQ, a division of Standard & Poor's, and Yahoo! Finance.
TTM = trailing 12 months.

While companies like Valero Energy, with fantastic annual dividend growth rates, are certainly impressive, a 1.1% yield is hardly something I'd like to retire on. The experts at Motley Fool Income Investor are focused on companies that offer a yield of 3% or better.

But will those dividends last -- and will you get a bigger raise next year? For example, Canada is undergoing a massive overhaul in how it treats tax-advantaged royalty trusts, such as the high-payout Penn West Energy Trust, with its whopping 8.3% yield. Our experts can provide skilled analysis on which dividends are sustainable -- and which will likely be increased.

Analyst James Early and the whole Income Investor team can help point you to the handful of the thousands of public companies that can secure you a third income for life. You can even try it free for the next 30 days -- just click here.

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This article was originally published Nov. 17, 2009. It has been updated.

Jim Royal, Ph.D.  owns shares in Penn West. Coca-Cola is both an Inside Value and Income Investor recommendation. The Fool has a disclosure policy.