If you're investing for your retirement, there's one very important performance metric that you're not likely already tracking. That metric is your year-over-year change in dividend income. Whether you're approaching your retirement or living it now, that change in income will likely tell you more about the lifestyle you can expect your investments to provide you over the long haul than just about any other.
After all, if you're looking forward to a long and comfortable retirement, you're going to want to make sure your money lasts at least as long as you do. A big part of seeing your money last is to try to assure your portfolio can kick off more cash to you each and every year, to cover inflation as well as your current costs of living.
Dividends are your best hope
Bonds may be a traditional source of income for investors. These days, though, their low yields and fixed coupon payments mean that they're little more than guarantees that you'll lose purchasing power over time, especially if you're investing in the "safety" of U.S. Treasury bonds.
Among income-paying investments today, few are as attractive as dividend-paying stocks. That's especially true for those companies that have not only maintained strong dividends but have also managed to fairly consistently raise their payments, too. That combination is absolutely critical to building a portfolio whose payments have a chance to keep up with inflation no matter how long your retirement lasts.
As an example, my family's own portfolio is built on finding stocks that meet those characteristics, and the chart below shows our year-over-year dividend income change over the past several years:
Year-Over-Year Change in Dividend Income
Source: Author's personal Quicken records. *YTD through Nov. 22, 2011, vs. all of 2010
It's still November, yet we've already seen a better than 20% improvement in dividend income over last year. That's not bad, given the go-nowhere market. Granted, it isn't a "pure" investment performance number, as it muddies the effect of three key factors in the total change number:
- Dividend growth.
- Dividends on reinvested dividends.
- Dividends on newly invested capital.
Of those three factors, only the first two would "count" in a pure investment performance measure, and only the first would matter to a retiree actively taking income from a portfolio. But speaking of that growth potential, check out the actual year-over-year dividend performance of companies we partially own:
2011 Dividends Paid
2010 Dividends Paid
|Lennox International (NYSE: LII )
|Lowe's (NYSE: LOW )
|Mattel (Nasdaq: MAT )
|Microsoft (Nasdaq: MSFT )
|Waste Management (NYSE: WM )
|Kroger (NYSE: KR )
Source: Yahoo! Finance as of Nov. 22. *Includes estimates for expected dividends not yet paid
It's not 20% growth across the board, but if our dividend payments were at the level that they covered our costs of living, it'd certainly handle inflation. Best of all, it didn't take a degree in rocket science to be able to identify companies capable of rewarding their shareholders like that. All it took was asking (and answering) three simple questions:
- Is the dividend covered? In other words, is its payout ratio below 100% of earnings?
- Is the company financially stable? In other words, is its debt-to-equity ratio below two?
- Does the company have any sort of track record of raising its dividends?
No promise for tomorrow -- but a decent chance
Granted, we still don't have a guarantee that our companies' dividends will always increase. Indeed, our stake in Life Partners Holdings (Nasdaq: LPHI ) has me worried right now, as the company has been silent about its anticipated dividend for this quarter -- when in past years, an announcement would already have come. That dividend may never appear, as the company struggles to regain its footing after having its core business practices questioned in The Wall Street Journal and investigated by the SEC.
Still, that risk is why we take Benjamin Graham's timeless advice and diversify our holdings across industries. The market may be a game of roulette, but we'd much rather be the casino than the gamblers. Our portfolio covers the gamut from groceries to trash, and from toys to productivity software. Because of that very real risk of watching one (or more) of our investments potentially go into the trash bin, it would be crazy to not diversify.
And while even diversification isn't a guarantee of success, recall that 2008 was the year of the great global financial meltdown and all-around panic. If our change in dividend income during that year is any indication of what could happen the next time the financial world falls apart, it does indicate the merits in investing this way. All in all, I'd still rather take my chances with that than accept the guaranteed loss of purchasing power from owning government bonds.