When I sold my dividend stocks in 2015 my portfolio was worth $100,000 and generated about $4,000 a year in dividend income. I’ll admit it was motivating to watch the dividends grow each year as I added new money to my portfolio and companies increased their payouts. I regularly tracked my progress and projected out scenarios where I could retire and live off the dividends.
Indeed, following some of the popular dividend investing blogs was equally inspiring, as their income-generating portfolios already approached the tens of thousands annually.
But one thing I learned about myself as I sorted through my own behavioural biases was that as a thirty-something investor I was fixated on investing for income rather than total returns. I was decades away from retirement, so why did it matter how much income my portfolio generated right now? Instead, I should focus on saving and growing the entire nest egg.
Investing for Income
One excellent blog I’ve followed for years is My Own Advisor, written by Mark Seed from Ottawa. Mark chronicles his journey towards financial independence and retirement through his unique investing style – a hybrid of dividend stocks and index ETFs.
Mark regularly updates his dividend income and posts thoughtful commentary on the choices he makes inside his portfolio. One recent update got my attention when Mark wrote about some changes to his TFSA; selling off a Canadian ETF to focus instead on more dividend stocks.
On the changes, he said:
“I’m striving for more dividend income from my portfolio; not relying on capital gains in our Canadian stock portfolio as we approach semi-retirement.”
Mark has set-up a cash-generating portfolio that currently churns out more than half of what he needs to live off of in semi-retirement. It’s encouraging to watch the compounding effects of those dividends as they snowball into bigger and bigger numbers each year.
But here’s the thing. Mark doesn’t need those dividends today. He needs them in retirement, which might be 10 or 15 years away. Why not adopt a total return approach during your accumulation years and then switch to an income approach when you need the money in retirement?
Imagine for a moment there are two investors, Income Ernie and Total Return Tim. Both Ernie and Tim are 30 years old and have saved $100,000 in their retirement accounts. They each hope to generate annual income of $30,000 by age 55.
Income Ernie invests in dividend stocks, focusing on blue-chip companies that have a track record of growing their dividends over time. Total Return Tim buys a couple of broad market index ETFs, opting for maximum diversification and a relatively hands-off approach.
Both Ernie and Tim save $10,000 per year for the next 25 years and earn a comparable 6 percent annual return. Each of their portfolios is worth $1 million, with Ernie’s spinning off $30,000 per year in dividend income, while Tim’s portfolio of ETFs yields just 1.8 percent, or $18,000 per year. Tim is $12,000 short of his income goal.
But after meeting with his good friend Ernie, Tim sells his ETFs and buys the exact same stocks that Ernie holds in his portfolio. Problem solved. Tim’s portfolio now generates $30,000 per year in dividends, the same as Ernie’s.
The allure of investing for income can make it seem like the annual compounding of dividends has some sort of super-snowballing effect. As companies increase their dividends, the current yield rises in relation to the initial price you paid for the stock, making it seem like you’re earning even more money.
But it doesn’t matter whether you bought 1,000 shares of TD stock for $6 in 1995 or bought 1,000 shares of it yesterday for $63. The dividend today – 60 cents per share – is what matters, and in either case would pay you $600 every three months.
There’s nothing wrong with building up a cash-generating portfolio in your accumulation years. If you’re the type of investor who is motivated by the dividend needle moving up every year, I say go for it.
Just know that even if you choose to take a more hands-off approach to investing in your accumulation years, like I do with my four-minute portfolio, you can still flip the switch to a more active, income-oriented approach in retirement without missing a beat.