Now don’t get me wrong, there’s nothing terrible about following this advice.  A retiree who adheres to this plan has a great chance their portfolio will last the remainder of their life.  But isn’t there a better option?  One where the retiree needn’t worry about outliving their nest egg?  Luckily, there is a better plan.  Instead of drawing down one’s portfolio, a retiree can simply live off the dividends and interest their nest egg produces.  Following this method guarantees that one never runs out of money.  It is also easy to stick to, and will eventually leave one’s heirs with a tidy inheritance.  The one caveat of living off dividends and interest alone is that it usually requires significantly larger retirement savings.

This issue is discussed in further detail here:  Retiring on Investment Interest: Can It Be Done?

“A true interest-only strategy can work only for those with excess capital. If you retire with $1 million but only need $55,000 per year of supplemental income, keeping with our 6% assumption, you will need $917,000 to produce your income. That will leave   you with $83,000 that could be used for emergencies or irregular expenditures.”

“Be thorough and careful when working out the numbers.  Interest-only portfolios can work, but if you assume that one will work for you without working out the details, you may find yourself without adequate retirement funds.”

Due to the larger capital requirements needed for a dividends and interest only plan it may not be feasible for individuals who are
currently nearing retirement.  However, I believe this plan is perfectly achievable and a worthy goal for young investors.  There is no reason why someone with a long time horizon and a decent career can’t accumulate enough capital to implement this great plan come retirement.

Here’s a video of Cramer talking about how professional investors focus on the downside risk before buying into an investment.  He talks about company stock buy-back plans and dividends and how they can act as a buffer when the stock is going down.  Another good thing to look at is how much debt the company has and whether it has enough cash coming in to pay it and run the business.

P.S.  One of the best books that addresses this subject is The Intelligent Investor by Benjamin Graham.  Graham discusses in detail how to avoid catastrophic losses by focusing on buying investments with a “margin of safety”.  This tip is one of the reasons why Warren Buffett is so successful.  Check it out if your serious about investing.

Why Dividend Paying Stocks Outperform

1. Strong Financials - Companies that pay dividends tend to be more financially stable than non-dividend payers.  In order to payout dividends, a business must have the free cash flow and financial strength to support the payments.  This means that dividend payers usually have robust profits and manageable debt levels.  A long history of consistent dividend payment is a good sign that a business is fiscally fit.  Likewise, watch out for companies that have stopped or reduced their dividends; as this is a sign of financial distress.

2. Shareholder Friendly Management – When making an investment in a stock, it’s important to remember that the quality of the company’s management is almost as important as the business itself. Decisions by management have an enormous effect on the value of your stock.  This is why it’s vital that the firm’s executives have it’s shareholder’s best interest at heart.   Executives that squander cash on frivolous spending and unwise acquisitions do a disservice for shareholders.  While, companies that distribute a portion of their cash flow in the form of dividends are constantly rewarding their shareholders.  Dividend payments (especially increasing ones)  are a good sign that your company has a shareholder friendly management team.

3.  Buffer In Bear Markets – Dividend paying stocks tend to outperform non-payers even more during bear markets.  The reason for this is because as the price of a stock falls, it’s dividend yield increases. This effectively increases the stock’s attractiveness to investors.  For example, a $50 stock paying $2 per share in dividends yields 4%.  If the price of the stock falls to $40 than the stock is now yielding 5%.  During market selloffs there comes a point where investors looking for income will begin buying up shares in high yielding stocks.  As a result, dividend payers tend to fall less than non-dividend payers in bear markets.

4.  Dividend Growth – Many companies that pay dividends are the market leaders in their industries. This allows them to grow revenues and profits year after year.  As their profits grow, the amount of dividends they payout per share tend to increase as well.  Investors holding shares for many years benefit from this because the yield on their investment increases and compounds.  

For instance, let’s say you purchased 100 shares of Procter & Gamble (PG) at $61.25.  In the first year you would be paid $1.60 per share for a yield of 2.6%.  Now lets assume that over the next decade PG increases it’s dividend by 9% per year.  (PG is famous for increasing their dividend annually so this is reasonable).  In 10 years the dividend would have more than doubled to $3.79 per share and your investment would be yielding you more than 6% each year.  Keep in mind that this is only a simple example of the power of dividend growth.  Here’s another great example.

Begin Yielding Wealth

Now that you know the advantages of dividend investing, you can begin using it as part of your investing arsenal.  Start looking for companies with long histories of increasing their dividends.  Also make sure any company your buying into has the cash to keep paying it’s dividend in good times and bad.  You can ensure this by researching the stock’s dividend payout ratio.  

To get you started you may want to check out the S&P 500 Dividend Aristocrats.  These are the top dividend paying stocks that have increased their dividends annually for the past 25 years.  As for my recommendations, I personally own the following dividend payers… Diageo (DEO), Philip Morris International (PM), Heinz (HNZ), Procter & Gamble (PG), and Nike (NKE).  As always, remember to do your own research before investing.