Help Me Retire Podcast - Episode 25

How to beat inflation in retirement

Show notes:

Would you take a job today... if you knew you wouldn’t get a raise for the next 30 years? Of course you wouldn’t... but retirees are doing essentially the same thing every day...

In today’s episode of The Help Me Retire Podcast... I’ll show you how to invest for a rising income in retirement... income that potentially increases just as fast – or faster – than your cost of living...

This is the Help Me Retire Podcast… with your host… Mike Brown… Senior Wealth Advisor with Raymond James Financial Services… and head of Brown Family Wealth Advisors…

Mike is the best-selling author of Your Way to True Wealth: How to Make It Happen, Make It Last, and Make It Matter…

He and his team have been helping clients pursue their dreams of financial independence for the past 30 years… and in the Help Me Retire Podcast… he’ll share his best ideas with you…

And now… here’s Mike…

When you retire... the question isn’t... “Do I have enough income today?”  The smart question is... “Will my income keep up with me tomorrow?"

Because life doesn’t get any less expensive just because you stop working... Groceries... travel... insurance... property taxes... they all seem to keep going up...

And here’s the math. At 3-percent annual inflation... your cost of living is going to double about every 24 years...

So over a 30-year retirement... fairly common these days... you’re going to need about two-and-a-half times more income at the finish line... they you did on Day One... just to maintain the same standard of living...

And if your income is fixed... as it might be with CDs... bonds... and some annuities... and your expenses keep rising... you could wind up going broke... on the installment plan...

Today... I’m going to explain the Dividend Method... a way of investing that puts rising dividend income at the center of your retirement plan...

The idea is simple... but powerful...

Own a diversified group of quality businesses that share their profits with you in cash... and have a habit of consistently raising those cash payments year after year...

And when those dividend checks grow faster than inflation... you’re no longer simply maintaining your standard of life in retirement... you’re actually improving it...

Inflation isn’t something you notice every day... it kind of creeps up on you...

Eating out at your favorite restaurant costs a few dollars more than it did last month... your utility bill has a new surcharge... the dues you pay your homeowners association are higher than last time... and every year... you seem to be paying more for health insurance...

And once you’re retired... you’re not going to get promotions and raises anymore...

Now... Social Security benefits have cost-of-living adjustments every year... so that will help some...

But most pensions don’t... they’re fixed for life... as is the income that most annuities pay...

And when it comes to investing... fixed-rate CDs... bonds... and other fixed-income investments... they seem very low-risk...

But the reason they call them fixed-income investments... is that the income remains fixed... no raises... and they tell you that right up front...

So you tell me... if you get income from an investment that’s guaranteed not to increase over time... it means that income is losing purchasing power every year you hold it...

Would you still consider that low risk?

I know of one kind of investment... only one kind of investment, in fact... that is capable of paying you income... that rises over time... and I’ll share that with you in just a second...

We’re talking about getting income in retirement today... and why it’s so important not that you have enough income to support your lifestyle... but also that the income rises faster than you need it... faster than inflation...

There’s one type of investment that has consistently offered that kind of income... for decades...

It’s equities... stocks... and the dividends they pay...

But before we go any further... let’s talk about what stocks can’t do... and how they’re different from bonds... and CDs... and other fixed-income investments that promise regular income that doesn’t go down... OR up...

Dividends from stocks don’t work that way... dividends don’t come with guarantees...

Dividend-paying companies... however successful they might be... can’t promise you’ll get a raise next year... or even that they’ll pay a dividend at all...

Unlike most fixed-income investments... there’s no return of principal guarantee either... and there’s certainly no guarantee that share prices will rise in the future...

Finally... when it comes to the income itself... you should know that dividend yields on stocks... tend to be lower than what bonds are paying at any given point in time...

So... why would retirees want to own dividend-paying stocks... especially if they’re looking for income to live on in retirement?

Let me give you some reasons...

First... dividends are cash payments... Profits are on paper and can be all over the place... but as they say... you can’t fake dividends...

Second... a long history of dividends can be a sign of quality... The company is saying... in effect... we’ve earned enough in profits to share with our owners... and we’re confident enough that we’ll be able to maintain these dividends in the future...

Third... you can spend that cash to cover your expenses in retirement... without having to systematically liquidate your portfolio. If you’re generating enough investment income to support your lifestyle after adding in Social Security... you may never have to sell a single share for the rest of your life...

That means you won’t have to worry about selling at the wrong time... such as during a bear market. And if your retirement success is based on dividends instead of stock prices... then a lot of the risk of owning stocks in the first place... simply goes away...

Fourth reason to consider dividends... and I think this is the real secret... is if you can find companies that increase their dividends... year after year... it means you’re getting not just an income to live on... every time one of your companies increases its dividend... you get a raise...

Some retirees favor bonds over stocks... because they believe bonds pay more income than stocks...

That might be true over short time periods... but not over longer spans of time... like... the number of years you’ll probably live in retirement...

If you go back 30-years... say... to the beginning of 1995... you’ll find that triple-A-rated corporate bonds were paying yields of nearly 8-and-a-half percent, according to Federal Reserve data...

You could have bought a 30-year bond for your retirement... and earned nearly 8-and-a-half percent in income every year for the next three decades... at the end of which you would have gotten all of your original investment back...

Not a bad deal, right?

Especially compared with stocks... the S&P 500 was paying a dividend yield of less than three-percent at the beginning of 1995... only about a third of what quality bonds were paying...

But the yield on those bonds stayed fixed for 30-years... while consumer prices were more than doubling...

You might be surprised to learn that dividends on the S&P 500 didn’t double over those three decades...no... S&P dividends increased nearly six-fold... easily exceeding the total bond income you’d have received over those three decades... and well ahead of inflation...

The Dividend Method focuses on finding companies that have consistently increased their dividends over time... giving shareholders income today... and even more income in the future...

Next... we’re going to talk about where we find companies that can do these things...

If you’ve read my book... Your Way to True Wealth... you’ll remember that I dedicate Chapter 7 to the six, specific things we look for before we add a stock to a client’s portfolio... and the core of every portfolio we manage is made up of a couple dozen companies that fit the bill...

One... start with quality. You don’t want to have to worry about whether a company we invest in is going to be around after the next recession. So, we look for companies that make durable products we all need to buy... trusted brands... services their customers can’t do without. Those companies don’t just survive tough times... they thrive over long stretches of time...

Two... you want to see a strong financial foundation. Balance sheets matter... cash reserves matter... credit quality matters. We want to own businesses that have the ability to keep paying... and keep raising... their dividends... through recessions... crises... and other surprise...

Three... you want a business that’s growing... not only increasing its dividend over time... but growing earnings as well. If a company’s profits stop growing... the dividend will almost have to stop increasing at some point... and we don’t want that. Remember... dividend growth comes from earnings growth...

Four... look for something called the “payout ratio.” That tells you what percentage of a company’s earnings that is being paid out to shareholders in dividends each year... If the payout ratio is too high... for too long... we start to wonder if the dividend is sustainable... and again... we don’t want to have to think about that...

Five... look at the company’s dividend yield. That’s the dividend... divided by the share price... So, if you pay 50-dollars for a share of stock... and you receive a dividend of 2-dollars this year... we say your stock has a dividend yield of 4-percent... and we look for stocks that pay dividend yields that are above the market average... That’s going to give you a starting income that’s meaningful compared with other investment options...

And six... the last thing we look for with the Dividend Method... is value. Just like anything else you buy... you want to get your money’s worth. If you can find a company that satisfies the first five criteria... AND you can buy its stock at an attractive price... you’re increasing the potential rate of return on your investment... you’re also avoiding a lot of the risk you’re taking by paying too much for it...

So... what does your life in retirement look like when you own a portfolio built around the Dividend Method?

You’re retired... and you’re getting regular income from Social Security... maybe a pension. That’s your income base... money you can spend on the necessities of retired life...

Then... the dividends start showing up... In year one... your total income covers a significant portion of your spending. Year two... those dividend payments are large. By year three... larger still...

After a while... you realize your lifestyle is being funded by at least two things... a Social Security check that goes up with inflation... and a stream of dividends that’s been rising even faster... You’re living on your dividends... and you’re living on raises...

That’s a very different experience than someone who’s following... say... the four-percent rule... selling shares every month to raise cash. And having to sell more shares when the market is down... which is the opposite of dollar-cost averaging...

If you built your retirement savings by systematically adding to your 401-k... you’ve been dollar-cost averaging... and all the market volatility you’ve seen over your career has actually helped you build wealth...

You know what we call dollar-cost averaging when you try to do it in reverse once you’re retired? Dollar-cost ravaging... Market volatility destroys wealth when you have to sell investments at the wrong time...

But if you don’t have to sell when the market is down... or maybe ever... then stock prices don’t matter so much... Volatility doesn't matter so much...

Or... as I used to tell people in my retirement seminars... you don’t need to worry about chicken prices... when you’re living on the eggs...

I’ve always believed that it’s not how your investments behave that determines your success... It’s how you behave...

And when your portfolio is generating enough income for you to live on in retirement... and that income is rising faster than your cost of living... I think you’re going to behave better...

Headlines get scary sometimes... Stock prices rise and fall... that’s volatility.

And when you focus on the price... it can feel like riding a roller-coaster... But if you focus on dividends... and watching those dividends slowly, consistently rise over time... you’re not riding a roller-coaster... you’re riding an escalator...

So, here’s something to consider... The next time the market’s giving you fits... take a look at your portfolio and see how much income it’s generating...

Is it about enough to cover your spending needs in retirement? And more importantly... has it been increasing faster than inflation?

If the answer to either of those questions is ‘no’... it might be time to think about doing things a different way...

What have we learned today?

• At 3-percent inflation... your retirement income will need to double... if not triple... over the rest of your life just to maintain your standard of living...

• That means... more than likely... you’ll need your investment portfolio that pays you what you need today... and will pay you even more in the future to cover those rising costs...

• And in all my years... I’ve found no investment that generates income that consistently rises over time faster than inflation... other than owning shares of successful, growing, dividend-paying companies...

• We work with people transitioning into retirement... so that strategy... which we call the Dividend Method... is at the core of every portfolio we manage for them...

• To find those stocks... we look for quality... financial strength... consistent growth... a dividend that’s sustainable... above-average yield... and an attractive price...

So, if someone tries to tell you that you can’t live on your investment income... that you’ve got to systematically liquidate your nest egg and hope you die before the money runs out... or that you’ve got to turn that nest egg over to an annuity company for a promise of income that will never go up...

You tell them they’re wrong... because people are doing just that every day... living off Social Security and rising dividends...

How do I know this? Because my family and I have been helping them do it... for the last three decades...

You just have to know how...

---

Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC.

Investment advisory services are offered through Raymond James Financial Services Advisors, Inc.  Brown Family Wealth Advisors is not a registered broker/dealer and is independent of Raymond James Financial Services.

Any opinions are those of Mike Brown and Brown Family Wealth Advisors and not necessarily those of Raymond James. This material is being provided for informational purposes only and is not a recommendation. There is no guarantee that these statements or opinions will prove to be correct. Investing involves risk, and you may incur a profit or a loss regardless of the strategy selected. Past performance is not indicative of future results. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. Dividends are not guaranteed and must be authorized by the company’s board of directors. A company’s future ability to pay dividends may be limited. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise. Rates of return and inflation can vary over time.