Follow the dividend investment decisions of a person who has no background in financial investment and wishes to take control of their financial future.

Is DGI the Perfect Answer to Inflation? - 24 Jan 2015 14:48

Tags: i-bonds inflation planning reit

Finding an investment product that can provide an income and at the same time continually rise to exceed the inflation rate is a primary goal for many retirees or soon to be retirees.

Finding such a vehicle is a daunting task. Fixed Income (bonds, preferred stock & fixed annuities) while low risk, operates just as it names describes. They provide a fixed income over time with no increases. It is predictable but cannot combat inflation.

Investing in stocks on the other hand does have the potential to grow and beat inflation. In the world of stocks, the dividend growth investing (DGI) strategy claims that a stock that continually grows their dividend is a sound hedge against inflation. But is this really the case? To prove this theory I analyzed a small basket of DG stocks that have been paying dividends for 25 or more years:

  • Aflac (AFL)
  • AT&T (T)
  • Coca-Cola (KO)
  • Emerson Electric (EMR)
  • ExxonMobil (XOM)
  • Johnson & Johnson (JNJ)
  • Leggett & Platt (LEG)
  • McDonalds (MCD)
  • Procter & Gamble (PG)
  • Wal-Mart (WMT)

Note: Considered posting graphs for all stocks but that would have made this post pretty busy so instead contrasting graphs of PG & WMT will be used. If anyone would like the data for the other stocks leave a post and it will be provided.

Of all the stocks, only WMT has consistently increased annual dividends at a rate that beat inflation. This is rather surprising as they are so closely tied to the economy. Other than WMT, each position failed to increase their dividend that exceeded the inflation for at least one year. The primary data points discovered were:

Average Inflation non-beat; once every 8 years (7.88 yrs to be exact)
Average dividend growth to inflation rate growth during the non-beat; -5%

PGinflat.png
WMTinflat.png

While not perfect, DGI is pretty darn effective! Though one could argue that the years that they did beat inflation, the dividend growth exceeded the inflation rate by such a large amount that it compensates for any one-time loses giving your long term growth rate a positive factor and this is a sound statement.

But, what if your income did not meet or was just meeting your expenses at the start of retirement? You may have been planning on that growth from the start and the years you do not beat inflation could hurt. With people living longer it is not unreasonable to assume a 30 year retirement of which there will be 3 times during that period where income growth will fail to beat the inflation rate.

While DGI is extremely effective it is not a 100% solution. Question now is; are their alternatives that can reduce the risk?

Diversify with Real Estate Investment Trusts

REITS tend to be influenced by different factors than the overall market and has growth at different cycles. In theory this should also apply to their dividend growth. To confirm this I analyzed:

  • Realty Income Corp (O)
  • HCP Inc (HCP)

The two REITs dividend growth also failed beat inflation once every 8 years but that 8 year cycle was completely different. When our basket of stocks failed to match the inflation rate REITs beat it and vice-versa.

Another factor discovered is the amount they failed to beat the inflation rate was much lower on average; -1.3% versus -5% for our basket of stocks.

By diversifying with REITs we reduce risk and spread losses out over different years leading to the conclusion that some REIT positions are necessary components for DGI.

Are there other alternatives? Most likely…wish to share? I'm willing to listen & learn. - Comments: 0

DG Investing in a Taxable or Deferred Account? - 05 Feb 2014 15:23

Tags: 401k inflation ira roth taxes

I occasionally get asked if using a tax deferred account (such as an IRA) is better than a taxable account for dividend growth investing and my answer is always the same; it depends.

There is no absolute right answer and much depends on your goals and where you are in life. If your goal is to create an income flow during retirement then a Roth IRA or Roth 401K is your best solution.

If you are saving to build an emergency fund then a taxable account is your best solution as you can easily access your income stream without paying early withdrawal penalties. But this all depends on your age and how far along you are towards your goal. The closer you are to your goal or nearing retirement age (within 10 years) it would make sense to start placing all or some of your future investments into a tax deferred account while you still qualify. The ability to grow dividends at an even faster rate would be yet another tool to help combat inflation during your retirement years.

Besides growing your earnings in a tax free or deferred IRA or 401K there is an additional benefit that may be realized that investors should not overlook. Some U.S. States have a classification of being “tax friendly”. Tax friendly states, such as Pennsylvania, do not tax distributions from 401(k)s, IRAs, deferred-compensation plans or other retirement accounts. If you think a Roth account solves this think again. A Roth may help with federal taxes but States are under no obligation so “tax un-friendly” states such as Connecticut are not shy about taxing Roth distributions. If you are fortunate enough to live in or plan to move to a tax friendly State then consider having some of your investments in a tax deferred account.

Not sure if your state is tax friendly? Check out this neat tool from Kiplinger’s that summarizes all 50 States. Kiplinger's State by State Tax Guide Link - Comments: 0

Minimum Growth Rate - 27 Nov 2013 13:10

Tags: growth inflation

One screen for dividend growth stocks is the percentage growth rate. But. what happens if a stock (after you purchase) fails to increase at your preferred rate?

Most DGI folks have rules when to sell, usually if a company decreases or eliminates a dividend or even fails to increase a dividend (0% growth). But what if the dividend only grew 3%, you planned on 7% and you still like the business, do you sell?

In this case I actually use two rules, the first is to hold the stock for an additional year (sometimes two depending on circumstances) and see where the dividend growth moves from there. Every stock is bound to have a bad year and most growth rates are based on averages so a 3% one year may result in a 15% gain the next giving you an average of 9%. You must be flexible to accommodate for averages.

The second rule I have is to establish a minimum growth rate. Your selected growth rate is usually a preferred rate and may not always be achievable especially if the economy is on a slow growth path. So again to remain flexible you should have upper and lower limits for dividend growth.

To calculate a minimum growth rate for my portfolio I use a percentage based on the average U.S. inflation rate over the last 10 years plus 2%. A problem I have with yearly inflation rates is that they are averages. Inflation rates fluctuate from month to month so for my calculation I use the "Max" inflation rate for each year. Based on this theory my minimum growth rate stands at 5.6%. If a stock cannot maintain this rate it becomes a candidate for a potential sell (note that I said "potential").

Year Ave Max Min Div Growth (Max+2%)
2013 1.51% 2% 1% 4%
2012 2.08% 2.9% 1.4% 4.9%
2011 3.16% 3.9% 1.6% 5.9%
2010 1.62% 2.6% 1.1% 4.6%
2009 -0.35% 2.7% -2.1% 4.7%
2008 3.85% 5.6% 0.1% 7.6%
2007 2.86% 4.3% 2% 6.3%
2006 3.23% 4.3% 1.3% 6.3%
2005 3.38% 4.7% 2.5% 6.7%
2004 2.68% 3.5% 1.7% 5.5%
2003 2.27% 3% 1.8% 5%
10 Yr Ave 2.39% 3.59% 1.12% 5.59%

This second rule is for my overall portfolio. If I see my portfolio of stocks not meeting this growth rate I begin the search for new "buys" while reviewing my list for potential "sells". That said, I may have some stocks with a growth rate of 2% and others at 12% as long as the portfolio dividend grows between a min 5.6% and a preferred 7.2% annually then life is good. - Comments: 0


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