Generating income in retirement to cover your bills isn’t that easy. While the premise of dividend investing points to a strong retirement strategy, once you dig into the numbers, the nest egg you need to accumulate is quite large and out of reach of many.
What can you do to have a decent retirement?
What can you do to retire on your timeline?
Those are questions that I am going through. I have the accumulation part of the life journey under control. Even if you get some false starts, you can recover, but decumulation is not something we get to practice more than once.
The timing is also crucial, as starting in a negative year has a marginal impact compared to a typical year. Let us not forget about inflation, which has been out of control for a few years.
How Much Income Do You Need in Retirement
To understand the retirement income challenge, we need to understand a couple of numbers to work with when approaching retirement or financial independence.
Here is some simple math with no complicated taxes in place. If you want:
- $100,000 / year; you need $2,500,000 at 4% income (dividends or withdrawal)
- $80,000 / year; you need $2,000,000 at 4% income (dividends or withdrawal)
- $60,000 / year; you need $1,500,000 at 4% income (dividends or withdrawal)
In the scenarios above, we can assume some solid blue-chip stocks that can moderately keep up with inflation. The following stocks can represent a Canadian retirement portfolio example. It probably represents the most popular stocks owned by Canadians in retirement
The Retirement Challenge
Now that you have seen the numbers, you are probably thinking that you want the following as the portfolio amount is either too large or the income is too low.
- $80,000 / year; you need $1,500,000 at 5.33% income
- $80,000 / year; you need $1,250,000 at 6.40% income
- $80,000 / year; you need $1,000,000 at 8.00% income
The above is more in line with what future retirees have in mind. The income needed is generally fixed, and the portfolio value is usually what it is by the time you reach retirement age, so there are two options.
- Work longer to make more, and it’s not one year that will make a difference.
- Increase the yield on the income.
You see, the math is simple. The numbers are what they are, but now future retirees have to choose their investments wisely, and some of the long-standing dividend income investments have struggled a lot while the markets have been roaring recently. What gives?
NOTE: These are not yield on cost. They are market yield for today’s portfolio value. Yield on cost is an inferior metric to use. Regardless of your yield on cost, today, we all earn the same amount from the same share.
What’s Changing for Retirement Income?
Interest rates are still very low. Yes, if you have a mortgage, you love it. However, if you are retired, you must find ways to generate income from your portfolio without depleting it.
It’s not easy to transition into retirement unless you have a lot of money saved.
Businesses evolve. Look at the transformation in the technology world over the last twenty years. Whether you appreciate the changes or not is not the focus. The changes are here, and the world is moving at a much faster pace.
- Amazon, Shopify, and Alibaba
- Netflix and other Streaming content (you can watch an entire series in 1 night – binged watching)
- The iPhone and the Apple Watch
- Uber, DoorDash, and all of them
That’s to name a few business changes, but old businesses are not always immune to the impact of these changes. Some businesses are more stable, such as those moving goods or energy, but others aren’t.
Take the streaming companies. They are all in content production now, which drives their business models. The old businesses in the telecom infrastructure aren’t what they used to be. Those businesses must broaden their scope and evolve or face reality.
Understanding business qualities and the intangibles of their business is paramount to investing! This is where many investors ask questions when companies are in the news. Retail investors often do not understand the impact on businesses. Investing is 50% about the busines and 50% about the past performance. Why is that? The business is really what shapes the future trend of the company’s revenue and profit.
It’s also a black art as you can see from all the analyst predictions being mixed, and companies missing their guidance here and there. You have the glass half full (bull analyst) and the glass half empty (bear analyst) trying to make a prediction. That’s why the saying about monkeys picking stocks exists, and also why index investing has grown in popularity along with the 4% withdrawal rule.
Low interest rates and a fast-changing international business landscape are what retirement income investors are faced with.
The Old Income Is Challenged
The above helps illustrate that change is fast. With AI around the corner, more changes will happen, and they’ll be quick. If you look at history, the time between catalysts is shorter. In my lifetime, we have the internet, drones, AI, and autonomous driving, just to name a few. In my parents’ lifetime, you can include space travel.
Here is what it means to income—it’s something I have been trying to assess in my transition to retirement (financial independence).
Real estate is generally a good investment. (I don’t have any, but my brother does) Doing it on your own is a lot of work unless you can find a good property management company and buy at a decent price where you can still earn a profit after expenses. It’s not just about capital appreciation and just trying to stay afloat. Investors are now buying anywhere across Canada and hiring a management company to deal with rentals and problems. As a result, your returns have generally been fixed and consistent over the years. You can increase rent to keep up with inflation.
I thought investing in REITs would be great early in my investing career, but I changed my mind many years ago. There is no inflation protection, and if management isn’t good, the stock price can drop. We have seen many of those.
Chasing high-yield stocks usually leads to a drop in dividends and then a stock price impact. It’s a double whammy. Again, there is no inflation protection and an overall loss.
Canadian banks and some insurance companies continue to be stable income generators with good inflation protection. However, they will pay an average of 4% over the years, with dividend growth on par with inflation.
Utilities are faced with higher-interest loans even if they’re low and are limited to how much they can increase rates, so it’s a challenge for them to maintain decent dividend growth that can keep up with inflation.
The recurring story here is that not only is old income not really above 4%, but it’s also not keeping up with inflation as much as we would want.
What should investors do?
Rethinking Retirement Income
No, this isn’t about annuity.
It’s about thinking outside the box. By outside the box, we mean starting to be creative with the options available to an investor. Many already do the above, especially those with a lot more money.
Portfolio Safety First
To protect your downside, avoid withdrawing during the bad years. Plan two years of income in laddered GICs or the money market. This strategy is part of the retirement bucket strategy and provides safety, but it requires you to save and put aside $120,000 to $160,000.
Typically, with dividend investing, investors live from the income the investment generates, but it’s usually quarterly, so it’s a good idea to build up cash to use without waiting or living month to month on the income. Living month to month is risky, and the bucket strategy takes away the risk.
Portfolio Foundation
Invest approximately 50% of your portfolio in stable dividend-income stocks—no REITs or high-yield stocks, please. The stable dividend-income stocks are the dividend stocks found in the retirement model portfolio. Investing equally in each holding today would provide around a 4.8% yield.
The 50% is negotiable, but it’s about having a stable part of your portfolio without the need to sell.
Future Proof Your Portfolio
The remaining 50% is invested in dividend growth stocks (low yield), where companies appreciate more than their low dividends. This beats inflation, hands down.
The suggested withdrawal percentage from a portfolio is 4%, which you can use with a dividend growth portfolio since the yield below would be about 1.2% (invested equally). For many years, the theory has been proven that the growth keeps up or even outpaces the 4% withdrawals
Optimize Your Income
Lastly, if you feel comfortable, you can look at some covered calls or options ETFs, but you must understand what they mean. These are new products with hype and little history. It doesn’t mean they don’t do what they are advertised for, but sometimes, they can look too good to be true.
You can look at the corporate portfolio for examples. I have been trying to find the appropriate income strategy, and I started with covered call ETFs. Please read all the updates to see the changes I have made.
The only real safety is to have a larger portfolio and have saved more money than you need, or you significantly reduce your spending. Otherwise, you need to manage your portfolio strategically.
When combining a blend of dividend income and dividend growth, achieving the appropriate retirement income should be possible.