Model Retirement Portfolio

The focus of a dividend retirement portfolio is to generate enough income to cover expenses, keep the income up with inflation, and avoid depleting the portfolio. Unlike the generalized retirement approach, depleting the portfolio is not the primary strategy but is possible at a later stage.

There are definitely stages of retirement based on your health and goals, but the main concern remains the same for all retirees: ensuring you do not outlive your money.

If you can plan your retirement without counting on the Canada Pension Plan (CPP) or the Old Age Security (OAS) Pension, you are way ahead of the average retiree and should be comfortable. While you could count on some CPP payments and OAS payments, planning without it gives you a buffer of safety.

Retirement Portfolio & Income Generation

Long ago, the financial industry established what is considered an acceptable withdrawal rate to ensure that one does not outlive one’s retirement portfolio.

The withdrawal rate was established at 4% but it is very generalized and assumes retirement is not early and it also assumes there would be a certain rate of return on the fixed income portion of your portfolio. Ultimately, you need to know how much you will need to retire and you can easily estimate it using a simple retirement formula. An ETF portfolio can probably work with the standard withdrawal rule.

Seeing all the variables being challenged in the low-interest rate environment we have been in for a relatively long time, the 4% rule can no longer be trusted, and fixed-income investments do not provide the safe return they used to. The status quo no longer works.

I see DIY investors chasing high-yield stocks for the wrong reasons and it’s very dangerous for a retirement portfolio.

Dividend investing is a solid strategy for generating income and avoiding depleting your portfolio, but not every dividend stock works. You need to consider the dividend yield for your overall income, have dividend growth, and avoid dividend drops.

The dividend yield is an easy data point to access, but dividend growth is not easy, and assessing the dividend safety of a stock is another story. A retirement portfolio is in place during the decumulation and is an evolution of your accumulation, or wealth-building, portfolio.

Your Retirement Portfolio Must Keep Up with Inflation

First, a dividend yield above inflation is not how you keep up with inflation – that’s a misleading thought. The income is what you use for your expenses. To keep up with inflation, you want the income to grow at the same rate as inflation or greater; that comes from dividend growth.

Dividend Yield is for Income
Dividend Growth is for Inflation

Take a REIT with no dividend growth, for example, the distribution you received is fixed every year while your expenses increase. After several years, you end up needing more and more. If you are not adding more money to the REIT, you are not increasing your income. You need the income to grow through dividend growth to keep up with inflation.

Since the income comes from cash distributions or dividends, to grow the income, you have two options:

1. Increase your holdings, or
2. Receive a dividend increase

Option 1 is normally off the table when you are in retirement so that leaves you with option 2. Do note that not all of your holdings need to provide growth in dividends as long as the overall income increases by what you need.

The higher the dividend growth, the better, but generally, there is an inverse relationship between growth and yield.

Retirement Stock Filters

In the accumulation years, I aimed for a 10% dividend growth, and I am satisfied with a low yield since the stock price will have growth, but in retirement, we can make some adjustments to optimize income.

I am satisfied with a 3%-4% yield, a Chowder Score of 8% and a market capitalization over 5B. Large cap only – it’s not the time to take a risk on a smaller business.

Using the Dividend Snapshot Screeners, I get the following stocks. First table are Canadian stocks and the second table are US stocks. Not all screeners offer the data you need as a dividend investor, make sure to use the best dividend stock screener for your research.

Pay attention to the 3, 5 and 10 year dividend yield average (If you have access to the data) in order to make sure the stock has paid above your desired yield for consistency.

While there are more than 10 stocks that show up in each of the filters, I am going with 10 holdings form the TSX and 10 from the NYSE or NASDAQ. Those represent my core dividend payers but they do not have to be the only stocks.

The filter in the page is fixed but I found a couple of stocks outside with a lower Chowder Score that still attracted me. In the end, it’s not the individual stock’s ability to keep up with inflation that is important but the overall portfolio dividend growth.

Canadian Retirement Stocks

Based on the Dividend Snapshot Screener, I came up with the list below that matches my criteria. Nothing surprising if you are familiar with the Canadian stock market. Perhaps you already own them all.

Enbridge and TC Energy still meet the requirements but there is pressure from an oil consumption and environment perspective. You could decide to have none, one or both. One option is to swap with life insurance stocks.

There are ten stocks. All solid blue chip stocks from a Canadian perspective and if you were to have $50K in each, that would be worth $500,000 with an income greater than $22,000.

One note in this update to the portfolio is that Alimentation Couche-Tard is present with a low yield but Canoe EIT Income Fund is added to offset it. Both together should provide some good balance.

There are other names you can add, but I consider those to be core stocks for a Canadian retirement portfolio. Feel free to swap a bank or a telecom, both industries are pretty much an oligopoly and will have some protection by the Canadian government for the foreseeable future.

You get an approximate dividend growth of 4% which means you could still have a lower-yield stock like CNR or CP if you want. However, I intend to reduce my high-growth dividend stocks once I live from the income of my portfolio.

US Retirement Stocks

This is similar to the Canadian list but in general the yield is a bit lower. You would make around $18,200 in dividend for a $500,000 portfolio value in Canadian dollars and a yield of 3.77%. Obviously, the best account to hold the US stocks is in your RRSP.

Why hold US stocks in retirement? It’s simply a bigger economy and if you are not willing to hold $1,000,000 in the ten stocks above, you are diluting your Canadian holdings into lower-yield stocks or riskier holdings. The difference between the Canadian and US stock markets is significantly different.

Unique Investments For Higher Income

The companies above tend to pay 3% to 4% in dividend but as it happens, there are some holdings that can pay more.

You can invest in a covered call ETF specifically built to increase your income. One such income ETF is the ZWB ETF, or BMO Covered Call Canadian Banks ETF. You can earn over 5% without taking much risk but don’t expect growth.

Another interesting investment to consider is Canoe EIT Income Fund (TSE:EIT.UN) which is a managed fund that pays close to 10%.

A Word on REITs

Contrary to other investors, I am not keen on REITs. Real estate is a solid and stable asset class but when you invest in a REIT, you invest in a business that holds the real estate asset class and you rely on management to run the business.

REITs are a proxy to the real estate asset class and real estate stocks is a sector where you invest in stock equity. The physical building is an asset class like bonds and equities. There is a distinction between a REIT and a real estate building.

Moving past this nuance, I find the yield of many REITs high and risky. Sure, it’s appealing but I want safety and I want it for 10, 15 or 20 years and it’s impossible to predict safety like that for REITs.

I got burned with REITs and after watching REITs for the last 10 years, I see too many drop the distribution over time. If there is a REIT with a normal yield and it has a limited limited growth, why should I bother with the REIT in my portfolio over the best Canadian bank or the best utility stock? REITs have to convince me they:

• are more stable than other stocks (size)
• have similar stock growth than other stocks (keep up with the TSX)
• have similar distribution growth than other stocks (a decent chowder score)

What about Bonds?

No bonds for this model portfolio as it assumes the dividend income will cover your expenses. If it doesn’t then you delay and save more or you need to withdraw money from your portfolio. 

If you need to withdraw, you should have bonds. You should establish your strategy to have access to bonds or fixed income equivalents that will not fluctuate with the stock market.

It’s about having a cash wedge plan. Don’t live from the income you generate today. Your portfolio income should generate at least next year’s income.

The Transition To a Dividend Retirement Portfolio

The transition should not be sudden on the day you flip the switch to retirement. You want to ease yourself into the new stocks as you slowly start taking profits from your other holdings not fitting your retirement income goals.

One way to do this is start a position 3 to 5 years ahead of your retirement years. You can start investing and averaging into those different holdings.

My approach will go with a 5 year transition and see new money added to some of those stocks to build a position. With a few stocks not currently in portfolio, I can chose the stock with a better value when it’s time to buy and grow my position over time.

Depletion & Withdrawal Strategy

To avoid being caught in a stock market storm, there needs to be a strategy for cash. I plan to use my dividends and flow them through a set of cash accounts or a 1-year GIC as an example. 

I plan to have a full year’s worth of cash on hand (maybe two) and the following year is being filled by the incoming dividend income. Stock market fluctuation should not impact the dividend income.

If there is a need to sell stocks for income, I will consider bonds (ETFs or coupons) to avoid selling at the wrong time and shift part of the portfolio to fixed income.

Ultimately, income tax on investments will play a big role along with taxes on RRSP withdrawals. Learn the details on the various taxes on investment you will innevitably have to pay.