Dividends don’t count in retirement, even big ones

Here’s the thing, a dividend does not create value. A dividend is a permanent removal of value/cash from a company. Sometimes there’s nothing wrong with a dividend. But a stock sale and a dividend of equal value are, well, equal. The only difference is the tax treatment. I recently wrote that dividends do not count in retirement. In fact, the dividend does not add additional protection to reduce the risk of succession of returns. How could they, when a dividend and a stock sale are the same? In the comments section of that “dividends don’t matter” article, several readers challenged the notion, saying “yeah, but what about those big dividends”? Well, hang on. Even big dividends don’t count toward retirement.

Here are my recent articles.

Dividends don’t matter.

Dividends don’t count toward retirement either.

Some readers have suggested that the 1,000+ comments on the retirement article may have set a record for Seeking Alpha this year. I think it is simply “superb”, the more retirees and near-retirees who know the simple truths the better. And that is why I am writing these posts.

Take control of your income and retirement plan

When you come to terms with the fact that a dividend and a stock sale are equal, you can do much better in retirement. You are in control, not your dividends. You will find some clear examples in those posts that prove that dividends don’t matter.

So let’s get down to the little-known truth about high dividends and high income. It doesn’t matter. In retirement, portfolio success comes down to total return and level of risk, both.

For a demonstration, I will look to a sector known for its generous dividends – the telecommunications sector. We’ll take a look at the big dividend-paying stock – AT&T (T). And we’ll examine a period of stress, creating retirement income, through and beyond the financial crisis. Of course, utilities (including TV companies) and pipelines are popular with retirees because they often pay very generous dividends. And I like the space because it is one of the defensive sectors for retirees. I’m not gushing over my telcos and pipelines because of the dividends, I’m drawn to the lower volatility and solid total return potential. Ditto for consumer staples.

Here is a fascinating fact and article…

Defensive sectors performed twice as well as a balanced portfolio during the financial crisis.

In 2007, AT&T paid a 4% dividend. It then continued a very strong period of dividend growth over the period we will examine, from 2007 to the end of 2015. There was a 32.4% increase in dividends for that period. You can view dividend history on the Seeking Alpha dividend page for AT&T.

Generous dividends from AT&T vs. dividend cuts

In 2007, the company paid $1.0725 in dividends. In 2015, AT&T paid out $1.4197 in dividends. Dividends have been increased every year. Compare that to the ( IVV ) market that has experienced dividend cuts. In fact, it took 4 years to recover from the 2007 dividend cut.

We’ll compare AT&T to a balanced growth portfolio.

• S&P 500 (IVV) at 75%
• Bond market (AGG) at 25%

The Balanced Growth portfolio is a very modest return portfolio, again with those dividend cuts in the mix. On the bond side, AGG experienced massive declines in income from 2007 to 2015. From $4.9148 in 2007 to $2.6485 in 2015. It’s a terrible portfolio if you think income is important in retirement.

Here is the total return comparison using a hypothetical starting value of $1,000,000.

We see that investments have traded for higher total return, with the balanced growth model coming out ahead in late 2015.

And here is the decumulation (retirement) stage, providing income at an expense ratio of 4.1% – $3,400 per month.

Once again, we see the balanced growth portfolio come out ahead in retirement. The retiree with the better total return portfolio (with terrible income) also leaves the period in better shape. You will see that the trends of the accumulation and decumulation charts look very similar. That’s because dividends add absolutely no value over stock sales in retirement.

Under the retirement article, dividends don’t count, a stock sale and a dividend of equal value are the same except for tax treatment.

Success in retirement comes down to total return and level of risk. When you pay yourself a dollar –

$20 – $1 = $19 regardless of whether that dollar comes from a dividend or a stock sale.

You have the same remaining portfolio value (and share of earnings and free cash flow) regardless of the path you take to create income.

This chart demonstrates that dividends do not provide any additional protection against the risk of return succession.

Stock sales are superior in every way because you have complete control over the income created and the risk level of your portfolio.

Dividends knows nothing about proper expense ratio, financial planning, risk, an optimized cash flow plan, or your estate plans.

Let’s go even bigger

Massive dividends and specialist income can be popular with many retirees. But as you’ll discover, even higher dividends and income “don’t count.”

Next, I’ll use a recent pick from one of the most popular high-earning writers on Seeking Alpha. We won’t name names, but the holding company is Oxford Lane Capital (OXLC). The yield looks like a ridiculous 19.53% for the week of August 12, 2024. Of course, that kind of yield is not sustainable because even the best companies in the world can’t pay at that level. We will face capital destruction over time.

Of course, we know where that ends if the trend continues – at zero. You will also see that the income has been reduced dramatically in the last 10 years.

Here is the total return comparison to the US stock market.

Of course, this does not make sense as an investment in the accumulation stage. Drastic income is of no use compared to a simple total return approach. And the goal in accumulation should be to create the greatest possible portfolio value. More money creates more retirement income.

High income payouts are worthless compared to a rational approach to retirement as well. We will look at recent performance in a period of stress, through the COVID correction and the brief recession.

Here is OXLC versus the IVV market. We have an inflation-adjusted expense ratio of 4.1%.

High income payouts have no value. They don’t support value, they don’t help crash prices. Income does not help risk sequence returns.

I think it’s obvious that few retirees would be comfortable spending from this holding when they watch the value drop by 70%. In my experience observing retirees during the dot com crash and financial crisis, most of these retirees would sell the holding for fear of creating permanent losses.

This is the worst outcome. The high-income chase destroyed a lot of pensions.

Total return and level of risk

The success of the retirement portfolio comes down to total return and the level of risk – reduction in severe corrections. With that in mind, it should come as no surprise that low-volatility defensive stocks can be a retiree’s best friend.

Once again, take a look at that defensive sector via the financial crisis post (link above).

Look for consumer staples (XLP), healthcare (XLV) and utilities (XLU). You can overweight those ETFs or your stocks in those sectors. I like the idea of ​​defensive stocks working together with cash, bonds and gold.

Dividends do not count towards retirement.

For additional inflation protection, I like some exposure to oil and gas stocks. We can also consider a commodity splash (DBC). It is an important component of…

The all-weather portfolio for retirement.

Thanks for reading, see you in the comments section. I try to answer or respond to all comments and questions.

I hope you will consider the optimal approach to retirement funding – dividends plus stock harvesting while managing risk. We should also adopt an optimized cash flow plan for retirement.

Editor’s Note: This article discusses one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.