Take a look at your 12/31 investment statements. Specifically, review the dividends credited to your accounts on your statement. They are not insignificant if your portfolio is constructed of many different companies. Dividends from the equities you own are typically reinvested which boosts your account balance. Yes, you may take dividends in cash however I’m not a fan of this approach. Why? This limits your future growth when not reinvesting in the companies you own. In years like 2020, some companies stopped paying dividends entirely or adjusted their dividend rate down which may impact what’s available. For planning purposes, I view dividends as a helpful addition to be reinvested for tomorrow.
Dividends plus price appreciation in your investment accounts work together in supporting your financial goals. Often, dividends go unnoticed and this may lead to them being underappreciated in the role they play. This may be addressing college education funding or creating income as you repurpose your time. Regardless of the job, it’s important to recognize the role dividends play in addition to price growth with your investments. Consider the following example.
I’m about to turn 48, and my wife is 46. Let’s assume we want to repurpose our time at 60 and generate $10k a month of income for what will be the rest of our lives. The average joint life expectancy of a nonsmoking 62 year old couple today is greater than age 90. This means one spouse is still here after age 90 with income needs to be met. Personally, I think we’ll blow past age 90 as we’re not 62 yet, we have access to healthcare, and the ongoing advances taking place in the field of medicine are significant, but I digress. Think about the above scenario for a minute. We want to stop working at/or around age 60 which is in 12 years and then stretch our investments and savings for more than 3 decades. Thirty years is a really long time! Thirty years ago, I was 18 and preparing to graduate high school- how’s that for perspective?
My financial planner (me) says we must increase the amount we invest overtime to make this a realty. This is accomplished by routinely adding to what’s saved automatically from cash flow. In addition, my wife and I have the priority of funding three in state college educations for our boys and would prefer not to have a mortgage when we retire. Not carrying mortgage debt at and through retirement allows us to stretch our investments further. Whatever we have saved and invested will last longer by not paying on debt when we repurpose our time. What may we learn from dividends so we may make this possibility a reality for our family? Couple key takeaways worth reflecting on:
- We (my wife and I) have to agree and understand that $10k a month today in 2021 dollars will not be $10k a month twelve years from now. Actually, it will be $12,500 +/- a month to generate the same purchasing power that $10k has today. The math assumes rising costs of 2.25% each year so we’ll have to adjust our planning. Let that soak in for a minute. This is an important concept that easily gets lost. The monthly number you have in your mind today must be increased to reflect increasing costs over time. It would be rather disappointing for us not to embrace the math and arrive at 60 only to learn we’re $2,500 a month off target! I share this as I’ve seen couples anchor around “the number” only to learn that it’s not relevant or able to deliver the standard of living they are accustomed to. Good news, one of the best solutions to hedge increasing costs is owning diverse equities and reinvesting dividends.
- Once we’re 60 we’ll need to have our investments continue to grow and expand so we don’t run out of money. How do we accomplish this? Equities and reinvested dividends. Owning a ton of small, medium, and large sized companies here in the US and abroad all run by really smart men and women. We’ll have to arrive at 60 with significant assets and then be comfortable with them expanding AND contracting just like last year for many years to come. This takes a strong stomach and meaningful cash reserves so not to get scared out of the market and retreat to all cash. Consider this, a $1,000,000 portfolio contracted 35% or so temporarily last year, dropping the balance to $650,000 for a while before recovering. A $3,000,000 portfolio contracting by the same percentage shed $1,050,000 temporarily before expanding back again. As dividends are credited even as the market contracts our dollars go further by reinvesting them to purchase more companies at lower prices. I continue to believe it takes a plan, a planner, and the ability to remain flexible when building wealth overtime. This keeps you from letting your emotions get the best of you and imploding your plan. Just my two cents, I may be biased though given my line of work and what I’ve witnessed the past 20+ years.
- We are NOT seeking principal preservation and safety from our assets. We ARE seeking assets with the ability to grow, contracting periodically along the way, and ultimately expanding again so we have a relevant income for decades. This is exactly the role dividends play within our equity portfolio. Sorry target date funds, you’re not invited to our retirement party nor will you support our goals of stretching income. Target date investment funds by design tend to get more conservative in their investment holdings by selling companies and loading up on cash each year as you approach your X date. Working completely against our desire to retire comfortably and stay comfortably retired. Pop quiz, do you want to guess which investment fund is predominantly selected in all current employer retirement plans today? Yup, you guessed it, target date funds. Aghh!
- Strong cash reserves at age 60 make reaching our financial goal a possibility, this cash is a necessity from my perspective. How much cash reserves in our plan depends on timing, other big-ticket purchases, and other variables we know and don’t. Because of this, planning margins matter as errors and opportunities are everywhere. We don’t seek a return on this cash just a return of it when it matters most to us. Embracing this concept saves us the time, worry, and record keeping of chasing current yields on cash. The sooner you accept that your cash doesn’t need to generate a yield, the happier you may be. It’s the job of your equity portfolio and the generated dividends over time that allow your plan to work and income to rise.
Taxes, life events, and other assumption changes may be factored into the above example. What can’t be disputed is the value and real results dividends offer when owning a diverse equity portfolio. This allows for funding the college education accounts above alongside investing for the desired retirement income.
For what it’s worth, it’s hard to envision repurposing my time in 12 years. It may be a possibility that arrives sooner or later than anticipated. Our plan(and all plans) will become more clear as time passes and assets grow and dividends are credited. By launching Flowerstone Financial I have already repurposed my time and am happy working with cool families who seek a relationship with a financial professional. I believe the sooner you know when you may repurpose your time the better influence this may have on your arrival date.
Should you have questions around your repurpose your time date or if you’d like assistance in determining that date, please reach out. We’d be happy to connect with you virtually and share what it takes to map out a plan and get there.