By: Dividend Sensei
In recent articles I’ve explained both why Social Security is in trouble, and why it’s easily fixable if we act relatively soon. However in reality today’s hyper partisan political environment means that Congress is likely to wait until the last minute to do anything. Unfortunately no matter how Social Security ends up fixed, the longer we wait the deeper any cuts to your benefits will be. And given that the average monthly benefit is only $1,404 per month in 2018 (hardly a princely sum) that could spell bad news for your dreams of a prosperous retirement.
Fortunately there is something that we can do to ensure our golden years are actually golden. Let’s take a look at why dividend growth stocks are the single best way to maximize the chances of a rich retirement, no matter what age you are today.
Why Dividend Growth Investing Is Best For Those With A Long Time Horizon…
Numerous historical studies show that over time dividend growth stocks tend to outperform the market, by a substantial amount. This makes them perfect those those with 10+ years to go before retirement (wealth building phase of life). For example a study by Ned Davis Research found that between 1972 and 2004 dividend growth stocks generated 10.4% total returns compared to just 8.5% for the S&P 500. That 1.9% per year outperformance might not sound like much but it adds up over time. For example if assuming you started with nothing and invested $1,000 per month over the time frame of this study, the dividend growth portfolio would have resulted in a $3,21,052 portfolio, compared to just $1,931,044 for a low cost S&P 500 index fund. That’s over $1 million benefit for choosing this tried and true investment method. Best of all? That dividend stock portfolio was 13% less volatile than the broader market over these 32 years. This means dividend stocks provided a 26% better risk-adjusted total return over that time period.
And if you think that’s just cherry picking, consider this. A recent study by Wellington Management looked at the performance of all stocks going back to 1929, meaning it included the Great Depression, when the market crashed 90% at one point. Wellington broke up companies into five quintiles (20% groupings), by their dividend payout ratios. The highest quintile, with an average dividend payout ratio of 70%, is a good proxy for high-yield stocks. Over the past 89 years those high-yielders outperformed the S&P 500’s total return (11.45%) 78% of the time. How does that compare to lower yielding stocks or those with no dividends at all?
- 1st highest payout ratio quintile: 78% beat market
- 2nd highest payout ratio quintile: 89% beat market
- 3rd highest payout ratio quintine: 56% beat market
- 4th highest payout ratio quintile: 33% beat market
- 5th highest payout ratio quintile (includes non dividend stocks): 44% beat market
Keep in mind that the broader market did great over this time, despite the Great Depression (1929 was market peak). However the stocks that paid out no or very little dividends were only about half as likely to outperform the market compared to those with high or moderate yields. Ok, so that’s some solid evidence in favor of dividend growth stocks, including high-yielding ones. But what if something has changed in the past few decades such as since 1929 or 1972? Is there more recent evidence that dividend growth stocks are what we should be betting our retirement on? Indeed there is.
Consider the famous dividend aristocrats, those S&P 500 companies that have raised their dividends for at least 25 consecutive years (and in some cases 50+ years). Between 2000 and 2017 we’ve had two strong bull markets but also two epic crashes where stocks fell between 50% and 54%. So it’s not surprisingly the S&P 500’s total returns over that time came in at a rather low 5.4% with very high volatility (standard deviation 18%). Keep in mind that since 1871 the S&P 500 has returned 9.2% annual total returns. This shows that with bad luck (two market crashes) the market’s returns can come in far below what one would expect just looking at historical averages.
But look at those aristocrats! They not just nearly doubled the market’s total returns, but managed to even beat the market’s historical return over the past 147 years. And they did it with far less risk (volatility). In fact on a risk-adjusted basis the dividend aristocrats beat the market by 77%. To give you a sense of how powerful this 17 year outperformance has been consider this. If you had started invested $1,000 per month on January 1st, 2000, (right at the tech bubble peak) then a low cost S&P 500 index fund would mean that by the end of 2017 you would have had a $338,466. But if you had invested in dividend aristocrats (like the ETF NOBL) then your portfolio would be $557,448, or 64% larger. That, my friends, is the power of quality dividend growth investing at work!
Ok, so dividend growth stocks are a great way for younger people to compound their wealth and build up a large enough nest egg to retire comfortably. But what about older investors such as those with less than 10 years before retirement (maybe even none)? Well the good news is that high-yield dividend stocks can also save your retirement dreams even if you already retired.
I'm an Army veteran and former energy dividend writer for The Motley Fool. I currently write for both Seeking Alpha, Simply Safe Dividends, and DividendSensei.com My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams, and enrich their lives. With 22 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams. I'm currently on an epic quest to build a broadly diversified, high-quality, high-yield dividend growth portfolio that: 1. Pays a 5% yield 2. Offers 7% annual dividend growth 3. Pays dividends AT LEAST on a weekly, but preferably, daily basis