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Rising Dividend Yields Could Be A Boon For Income Investors

With the most recent stock market downturn and much-increased volatility, many investors are fretting and rubbing their hands together with anxiety. But income-oriented investors might want to instead celebrate, especially if they have cash they can begin moving into solid companies that now sport a higher dividend yield.

Just one year ago Exxon (XOM) had a dividend yield of 2.9%. But after a stock decline of nearly 30%, its dividend yield is now 4%. Johnson & Johnson (JNJ) had a dividend yield of 2.7% earlier this year, but now has a yield of 3.3%. Procter & Gamble (PG) had a dividend yield of 2.8% late last year, but now has a yield of 3.9%.

I want to now take a look at how these rising dividend yields might impact a retirement portfolio in the long-run. There has no doubt been short-term pain for many investors, but for those investing for dividends and dividend growth for the future, this could be just what they needed to generate enough income in retirement such that they never run out of money.

The analysis I will run will compare a portfolio of dividend growth stocks where the previous portfolio had a dividend yield of 2% and the new portfolio has a dividend yield of 3.3%. For the purposes of this analysis I will assume that the dividends will grow by 5% per year and the price of the stock will grow by 2% per year. This way we can isolate just how important the starting dividend yield is.

Starting Yield

Div. Growth
(Annually)

Price Increase
(Annually)

Old Portfolio

2.5%

5.0%

2.0%

New Portfolio

3.8%

5.0%

2.0%

 

I will also make the following assumptions for a sample couple who is saving for retirement:

Inflation (CPI)

2.5%

Current Age of Both People

45

Age Of Retirement

65

Age When Both People Have Passed Away

85

Social Security at age 67 (combined)

$40,000 per year

Average Savings Rate

$10,000 per year

Total Investment Balance Today

$400,000 (50% in Taxable, 50% in IRAs)

Recurring Annual Expenses in Retirement

$70,000

Investment Mix

70% Dividend Growth Stocks,
30% Medium Term Treasuries

Using our retirement planner I first generated results for the plan using the older portfolio with the smaller dividend yield. The results are below:

Investment Amount At Retirement

$944,000

Investment Amount At Plan End

$0

Age Of Shortfall In Funds

85

Probability Of Never Running Out Of Money

29%

 

Note that even though they will have nearly $1 million when they retire, their funds do run out when they are 85 years old. Also, using our Monte Carlo analysis where 1,000 different scenarios are generated each year, we found that the probability that they never run out of money is a dangerously low 29%.

Now let's look at the results with the higher dividend yields:

Investment Amount At Retirement

$1,200,000

Investment Amount At Plan End

$625,000

Age Of Shortfall In Funds

Never

Probability Of Never Running Out Of Money

58%

 

This looks much more promising. We project that they will have over $600,000 left at the end of their plan (when they are 85 years old) and the probability of plan success went up by nearly 30%. This all from just a 1.3% increase in the dividend yield!

So income investors should not fret too much, especially if they are young enough to reap the rewards of higher yields going forward. The S&P 500 dividend yield is still only 2.1%, while the average of the past 150 years is a much larger 4.4%. If reversion to the mean finally occurs, we could be in for an amazing income investing opportunity.  

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