How Dividends Can Make the 4% Rule Easy

A popular retirement investing strategy known as the 4% withdrawal rule could be improved, provided you're willing to take a little risk by investing in high-quality dividend stocks.

Aug 28, 2014 at 9:57AM

There are millions of people in the United States currently in or near retirement. Many of them are looking for investment advice to manage their retirements. One of the more common pieces of advice calls for withdrawing 4% of your retirement nest egg every year to live on. At first glance, this makes sense, because life's inevitable expenses don't just stop once you leave the workforce. And, by withdrawing 4% of your retirement savings every year, you should have enough money to last you through retirement.

There may be a way to modify this strategy that could provide income to live on during retirement while adding the benefit of not draining your nest egg. Instead of withdrawing 4% of your money every year, you could invest in dividend stocks that pay a 4% dividend yield.

Although investing in dividend stocks is not risk-free, draining your nest egg every year carries the risk that you will outlive your retirement savings. If you're willing to dip your toes into the stock market, these high-quality dividend stocks can provide a nice spin on the 4% withdrawal rule.

The drawbacks of the 4% rule
One major disadvantage of the 4% rule is that for retirees whose savings are primarily invested in stocks and other investments, having to sell some of those investments in order to reach that 4% drawdown each year may seem far from ideal. This is a particular concern when interest rates are low, as yields on traditional savings vehicles like bank certificates of deposit are next to nothing.

A practical solution to these challenges is to invest some of your savings in dividend stocks so that you can earn some income from your investments without having to sell them off each year. This, of course, requires you to accept the risk -- and the potential reward -- of investing in equities.

A couple of ideas to get you started
There are still stocks that provide high yields without requiring investors to assume high risk. A great place to look would be the telecommunications sector. Two, in particular, are AT&T (NYSE:T) and Verizon Communications (NYSE:VZ).

Telecommunications companies have historically provided high yields, which investors crave for their income potential. For example, AT&T and Verizon pay dividend yields of 5.3% and 4.3%, respectively. Both companies can afford such generous payouts because their stable businesses produce lots of cash flow. In the first half of the year, AT&T raked in $5.2 billion in cash flow and paid $4.7 billion of that in dividends. For its part, Verizon generated $6.3 billion in cash flow and paid $3.5 billion in dividends over the same period.

Dividend investing: A twist on the 4% retirement rule
Investors in or nearing retirement are in a bind. Interest rates are at historic lows, meaning there's little income potential from traditional savings vehicles. A solution to this could be investing in dividend stocks.

To be sure, dividend stocks are not without risks. Investing in the stock market always carries risk. However, the risk of outliving your money should be considered, as well. Instead of withdrawing 4% of your nest egg each year and potentially running out of money, invest in dividend stocks and let the income they provide help make up for the slower drawdown of your retirement savings.

With dividend stocks like AT&T and Verizon, you can earn more than 4% from your investment, and your income should rise every year thanks to dividend growth. High-dividend stocks can be a great way to execute the 4% retirement rule.

How to get even more income during retirement
Social Security plays a key role in your financial security, but it's not the only way to boost your retirement income. In our brand-new free report, our retirement experts give their insight on a simple strategy to take advantage of a little-known IRS rule that can help ensure a more comfortable retirement for you and your family. Click here to get your copy today.

Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers