When it comes to retirement income, most people like to imagine having so much money that they can just live on dividends and interest. The reality is that most people will never have enough money to simply live off dividends and interest in retirement.
Several factors make dividends and interest income in retirement a challenge:
- When the idea of retirement was invented 100ish years ago, life expectancy was just a few years beyond the retirement age of 65. But as life expectancy increases and retirement age stays the same, a larger pot of money is necessary to live off dividends and interest.
- Right now, yields are low. The average dividend rate is less than 2%. CD’s at a typical bank are less than 2%. If you have 1 million dollars, that would only be $20,000 a year pre-tax. Investment-grade municipal bonds are barely paying on average 3.5%-4.0%. It’s hard to stretch $20,000 very far. The craving for higher yield has forced riskier assets to higher valuations as the hunt for yield and income intensifies.
- Two-year and ten-year treasuries, considered the safest and most risk-free rate of return when comparing investments, are both below 2% as of this writing.
Strategies to Make the Most of Dividends and Interest
Don’t Count on Them – at least not by themselves.
Vehicles that produce dividends and interest are great, and you should maximize what you can do with these. You need a strategy that will allow these investments to keep growing so they can keep producing those dividends and interest. Pairing this with other investment and income strategies will likely be your best bet.
Understand Dividend Yield
Dividend yield is the ratio of a company’s annual dividend to its stock price, expressed as a percentage. To calculate that dividend yield, you must first multiply the quarterly dividend by 4 to get the annual dividend. Then divide that number by the stock price. Multiply that number by 100 to arrive at the dividend yield. So if a stock was selling at $50 a share and the quarterly dividend is 50 cents, that’s a $2 annual dividend. $2 divided by $50 is .04 x 100 and you get a 4 percent dividend yield.
One way of taking advantage of dividend yield is to invest in a fund that looks for the highest current dividend yields, then reinvest or use this as part of your retirement income. There are always risks in such a strategy. Current dividend yields, of course, are not a predictor of future performance.
Dividend growth rate is the annualized percentage rate of growth that a stock’s dividend undergoes over a period of time. Hang with us here, because dividend growth is another consideration when it comes to a retirement income strategy. Similar do dividend yield, a currently growing dividend payout isn’t a guarantee of future similar results, but there are stock screeners you can use to pinpoint current companies whose dividends have increased.
In an ideal world, an investor can live on the cash flow produced and distributed by investments. In our previous article, we looked at a Systematic Withdrawal Plan (SWP) approach for retirement income. SWPs are more of a “set it and forget it” approach to retirement income. With dividends and interest, you can take several approaches: you can choose to manage your portfolio and avoid fees associated with that management. That is, of course, putting a lot of trust in yourself and your market acumen, but if you have the experience, that might be a plausible way to go. Otherwise, you will likely be working with a fund manager, with all the fees for services rendered that implies. But if you trust your manager and they have a strong track record with you and other clients, that might be the way to go.
This is one of several strategies we’re exploring as we look at retirement income options. Be looking for the next articles and if you have questions about your retirement strategy and what might be right for you, feel free to contact us. We’d love to hear from you!