Living off of the dividends to create retirement income.

Living off of the dividends in retirement is a popular concept and a very popular approach for many retirees. There is a comfort level that comes with not having to sell shares to produce income. But is it a wise strategy? Or does this leave money on the table?

As many of my readers will know I am a big fan of dividends. But out of the gate that certainly does not mean that this is the best approach, or that you should also fall in love with the Big Juicy Dividend. Many will argue that the dividend doesn’t matter. And they can state a case in certain respects. For why a dividend can matter I really like this post from Mark Seed at myownadvisor. That was penned in 2013 and Mark has certainly not changed his opinion.

I like that beyond the physical dividend payment the dividend sweet spot can find some more than useful factors such as profitability, quality and at times – value. In my new life-work/semi-retirement stage I simple like seeing those dividends getting dropped into the portfolio available for spending. I can tell your from experience that those dividends feel much different in the retirement stage (compared to the accumulation stage). That makes sense, there’s more immediacy. You can quickly go out and spend those dividends. When you’re in the accumulation stage those dividends and that total portfolio dividend income are simply numbers on a chart or table. You can’t touch them for years or decades.

I recently received some generous dividends from Enbridge, Royal Bank, TransCanada Pipelines and TD Bank. I also received some dividends from some of our US Dividend Achievers. Those US dividends are not as juicy but they offer the characteristics that I am looking for in retirement – growing dividends that come attached to very profitable high-quality companies. In 2015 I skimmed the Dividend Achievers Index that is available from Vanguard as the Dividend Appreciation ETF – ticker VIG.

VIG is a US listing, Canadians can access that index by way of VGG and VGH in a Canadian Dollar hedged version. That index is a smart beta fund that applies some financial filters, in addition to insisting on a history of dividend increases for 10 years or more. The yield for these funds (and for the collective holdings) is miniscule. If one were to live off the dividends from this approach they would certainly leave a lot of money on the table. There is a lot of value that ‘trapped’ in the share prices. A retiree would have to also sell shares to create meaningful income from those funds.

Dividends matter, or not. It’s up to you

I’ve been writing on Seeking Alpha for several years. And there is certainly an ongoing debate on dividend growth investing in the accumulation stage, and again on living off of the dividends and other income in retirement. I’ll admit that my opinion on dividends has evolved or become more nuanced as I research the matter, and more importantly talk to investors on both sides of the dividend coin. Initially I may have been more hard core on the dividend here’s Dividends Don’t Matter In Retirement Either. I followed that up with this article, Dividends Don’t Have To Matter, Redux.

Over time I was able to soften up a little. Over time I realized that those big juicy dividends can also make you feel warm and fuzzy. We should always remember that there is nothing more important than investor behaviour and if dividends help us keep on track in the accumulation stage or feel secure in retirement, those dividends have incredible value. Investing comes back to feelings and emotion. That’s more important than the math.

I harvested Apple shares to head to the island

I left my paycheque and the full time job I loved in June of 2017 to launch Cut The Crap Investing.

Related post: Saying Goodbye To Your Pay Cheque, It Ain’t Easy.

The first order of business was to pack up the Ford Flex and head down east to Prince Edward Island to spend some wonderful time with my daughter..

But I didn’t use dividends to help fund that trip. Nope, I sold some Apple shares – homemade dividends I like to call them. Apple is a great company that has beat the pants off of the market, and it pays a dividend, but the dividend is very small. You’re likely to see Apple in that Dividend Achievers Index one day.

Better companies will deliver a better retirement

And when I write ‘Better’ I am certainly alluding to better total returns. The greatest income is mostly created from the basket of companies with the greatest growth and greatest business success over time. One ‘slight’ nuance is that risk is important and of course much different in retirement. Retirees face that sequence of returns risk.

It might come down to total returns and a lower volatility portfolio, or that is a portfolio that will decline less (draw down) in a market correction. And certainly that generous and growing dividend income can help. Sequence of returns risk is created when we have to sell assets when they are down in price. If we have generous and growing income, we might need to sell less of the assets.

For a lower volatility portfolio most retirees will be well served by holding some bonds in the mix. Higher quality and longer dated bonds have a wonderful habit of going up in price when the stock markets are getting hit hard. One might simply use a Core Universe Bond Fund such as Vanguard’s VAB or iShares XBB. And many retirees will hold that cash cushion as well.

Dividend shortcomings

Depending on your account type and your income level dividends may not be the most tax efficient. Allowing the dividends to drive the bus may not be most beneficial in determining the order of asset harvesting (RRSP vs TFSA vs Taxable vs Rental Income/other) and the amount harvested from each bucket. And if we have a greater income focus that might keep us away from companies with greater growth and greater growth potential. A dividend focus could lead to less diversification. And when our RRSP accounts are converted to RRIF accounts we are mandated to remove larger percentages that increase over time. You may be forced to also harvest shares.

While dividends can also be wonderful on the emotional front, and they can have their purpose for reducing sequence of returns risk, we might not let the income considerations drive the bus. In retirement planning and retirement funding there can be more important considerations. On that please have a read of this and this on making the most of CPP and GIS benefits from Graeme of The Money Geek.

And other important retirement posts.

Retirement Income For Life: Getting More Without Saving More.

Pensionize Your Nest Egg with Annuities, Your Super Bonds.

Sticking to a retirement plan is more important

More important than the dividends vs a core coach potato investment approach debate is that you develop a sensible plan, and that will often include getting some advice from a retirement specialist.

Dividends can work. A core investment approach can work. Know why you are embracing your selected style or approach and stick to that plan like glue.

Robb Engen of Boomer And Echo had embraced dividend investing but after further evaluation offered Why Living Off Of The Dividends No Longer Appeals To Me. Robb is going to be just fine with his core indexing approach.

I have a hybrid approach. The Canadian companies that I wanted to own just happen to pay big and growing dividends. And I’m thankful as that does provide certain benefits. My US companies will require some additional share harvesting. I throw some bonds into the mix to manage that sequence of returns risk and the risk of dividend cuts and holds. It’s a simple plan. It’s a plan that I know I can execute.

Thanks for reading. Please offer your opinions and thoughts in the comment section.

Dale