Can Aspiring Retirees Be Nudged Into Living Off Dividends Alone?
Jun. 16, 2015 1:18 AM
- Can investment choices be constructed so that retirees are encouraged, or nudged, into investment choices that are good for them?
- Is nudging a form of mind control, or simply an effort to present choices in a way that steers people to make choices that are truly in their interest?
- If a retiree can be nudged to accumulate sufficient assets to allow him to live solely off dividends in retirement, will achievement of that goal truly be in his interest?
- We'll take a look at the FTG portfolio, a dividend growth portfolio, to see how it is taking on the challenge of allowing a retiree to live solely off dividends.
Much has been written about incentivizing people to invest for their retirement. Now that most employers have switched their pension plans from defined benefit plans to defined contribution plans via 401Ks and the like, it is imperative that workers take matters into their own hands if they wish to have any hope of a comfortable retirement.
As I've written in my Fill-The-Gap Portfolio series, the average working couple will receive only $28,800 in Social Security payments upon retirement, leaving them with a $21,200 gap between a bare existence and a comfortable retirement.
Several years ago data indicated that a great majority of workers never signed up for 401k plans offered by their employers. Many younger workers thought they had plenty of time to save later for retirement. Others determined that they didn't have the extra wherewithal to invest since meeting monthly bills was hard enough as it was. After many years of frustrating results and lack of sign-ups, some suggested that instead of making employees actively opt in to sign up, perhaps automatically enrolling them and requiring them to otherwise opt out might have a better result.
Automatic Enrollment Helps, but….
Well, this did help, and participation in these plans did show an increase, but many of those who were automatically enrolled simply refused to make any contribution into the plans, and again frustrated the good intentions of those who sought to be "choice architects" for good.
Still, many thought they had many years ahead of them to prepare for retirement, so inertia kept them from beginning to contribute. Inertia can keep some from starting to save, and can keep others on the fence for years as I've discussed in this article .
Others were frustrated with filling out the required paperwork. Some couldn't find the link on the sign-up website to begin their paperwork. Some couldn't decide how much to contribute into the plan, and others couldn't figure out which of the offered funds to funnel their savings into. In other words, even with automatic enrollment, there were many obstacles still standing in the way of greater participation.
Nudging for Good
In their book, "Nudge, Improving Decisions About Health, Wealth, and Happiness ," authors Richard Thaler and Cass Sunstein introduce their concept of acting as a choice architect for good, with a hypothetical story; Cathryn, a food service director and nutritionist in charge of cafeteria menus in hundreds of public schools, daily serving tens of thousands of children, engages in a conversation with her friend Adam who is a statistically-oriented management consultant to supermarkets.
Adam talks about how his work is all about suggesting placement and arrangement of certain foods in the supermarket to help companies increase sales of certain consumer items. He then suggests to Cathryn that she is in a very powerful position that would allow her to engage in experiments at various schools to determine how she can increase consumption of healthier foods by the children by nudging them into healthier choices.
She takes the challenge, and with the help of graduate students working on the project and compiling data for her, she finds that becoming a choice architect, she can order the presentation of various food groups, placing desserts last on the line for instance, and fruit cups, various fruits and vegetables first in the cafeteria line.
The experiment reveals that she can increase the consumption of particular food items by 25%. We can all guess which of the healthy foods saw increased consumption.
As Thaler points out, this is certainly a result that would be favored by all intelligent people. There is no political issue involved here, and this type of nudging could be supported by all right-thinking people.
Especially important here is the fact that no coercion or force has been applied. The multitude of food choices was still presented and the children remained free to choose any of them. The only thing that changed was how they were presented, in what order and at what height, which nudged the children into making decisions that were good and healthy for them.
What does all of this have to do with investing for retirement?
It has been pointed out here in many articles on Seeking Alpha, that the choice architects in the investment industry are continually encouraging investors to make choices that are good for the advisers but not necessarily so good for the investors.
I'm talking about the proclivity of advisers who encourage a great deal of churn in an investor's account, to the detriment of the investor's long-term goals. The trading in and out of the market that they encourage puts commission dollars in the advisor's pocket as it flows out of the investor's. Continual churn has these commissions eating into the investor's returns as it enriches the advisor and deprives the investor of the opportunity of time in the market and the ability to build wealth.
In addition, many advisors will suggest that their clients invest in a host of mutual funds. Many times, the choices presented will be those that have the highest management fees and result in much higher, ongoing fees received by the advisor for placing the client's money with the fund. I have written an article that clearly delineates the high cost to investors of investing in mutual funds. It was entitled Fire That Mutual Fund That Confiscates Your Wealth: How To Rescue Your Retirement.
With Investment Advisors, Dividend Growth Investing is Verboten!
At the same time, much Seeking Alpha commentary, in articles championing dividend growth investing, has decried the plain and simple fact that investment advisors never encourage investors to pursue a dividend growth strategy to fulfill their goals.
Because dividend growth investing, for the most part, relies on the employment of capital in high quality equities that have long histories of paying a growing dividend payment for the long haul, dividend growth investors believe that time in the market is essential. And more important than timing the market, time in the market allows for the continual compounding of those dividends. This type of investing strategy would not serve the short-sighted goals of investment advisors and brokers since it would deprive them of the large quantity of commissions that are coincident with the churn that has brought them their riches. The dividend growth style of investing also does not bring them the constant flow of a percentage of fees, like those collected by the mutual funds on an ongoing basis, and shared with the advisors.
All of this is to say that in furtherance of the goal to help investors reach financial independence and a comfortable retirement, investors could use a little choice architecture that nudges them towards healthy choices for their investments.
Thaler and Sunstein discuss an unintentional result in employee pay schedules. They relate how biweekly paychecks lead to higher saving by employees than monthly paychecks. What could possibly explain this difference? When receiving biweekly checks, two times per year the employee receives 3 paychecks in a month's time, leading to greater savings amounts. The worker believes that since he's already satisfied his obligations by paying his bills for the month, he's flush with extra cash that he can divert towards savings or investment.
This discovery is but one of many choices that employers can make if they wish to become choice architects for good, to further an employee's goal of financial independence in retirement.
A similar principle is at work when a homeowner chooses to make biweekly mortgage payments instead of monthly payments. The mortgage balance decreases that much faster and the interest paid out over the course of the loan decreases dramatically. This too, has the effect of good choice architecture leading to increased net worth and freeing up funds faster for investment.
Choice Architecture As Applied to Dividend Growth Investing
In the same way that receiving biweekly checks encourages more savings than monthly paychecks, the same psychology can be applied to aspects of dividend growth investing.
The FTG Portfolio has several examples of this principle imbedded in the strategy.
To illustrate, the FTG portfolio currently contains 3 equities that pay dividends on a monthly basis, rather than a quarterly basis. They are MAIN. O, and EPR. Not only does the receipt of monthly dividends afford the investor the opportunity to reinvest dividends more quickly and more frequently than a quarterly payer, it also allows for quicker compounding of those reinvested dividends, yielding higher income over time.
On top of those benefits, is layered the psychological effect. Just as the employee felt flusher when he received 3 paychecks instead of 2, twice a year, the investor now feels 3 times flusher, all year long, as he receives these monthly dividends. This inevitably leads to the probability that the investor will be his own choice architect for good as he nudges himself to reinvest on a monthly basis rather than a quarterly one.
Other methods for Self-Choice Architecture
1. An investor can direct his broker to automatically reinvest his dividends into the companies that issue them. This is commonly referred to as a DRIP plan, and usually comes with no costs involved, so brokerage commissions are saved and the investor gets the benefit of dollar cost averaging his purchases over very long time periods. This means that when prices are low, he's buying
more shares, and when prices are high he is buying fewer shares. The benefit of this strategy becomes apparent in down markets as more shares are accumulated for lesser dollars per share, and higher yields and income are accrued in the process. In up markets, he's automatically buying a smaller number of shares. The end result, over time, is the accumulation of shares at an averaged down price with higher income.
2. The investor can place limit orders in severely beaten down sectors, 20% to 25% below recent 52-weeks highs. Even when a market is in an overall bull phase, as it is now, sectors under stress can usually be found as investors rotate their interest from one sector to another. Examples of such distressed, out of favor sectors currently are Real Estate Investment Trusts and Utilities, beaten down on the interest rate fears swirling in the marketplace these past several months. Many of the equities in these industry groups are already yielding 0.5% to 1% more than they did just a short while ago and are presenting much better value as regards their historical P/E ratios and 5-year average yields. They have, therefore, become more attractive to dividend growth investors. The choice for good, therefore, becomes the active placement of limit orders on those names on the investor's watch list at prices that result in the yield the investor seeks to buy.
3. Parents who have a dividend growth investing mindset might consider setting up custodial accounts for their children at their brokerage company. Instead of paying the child a weekly allowance, the parent might make a weekly deposit into the child's account, introducing junior/she-junior to the world of dividend growth investing and allow the child to make investment choices from amongst companies they are familiar with, i.e. Disney (NYSE:DIS ). Mattel, Inc. (NASDAQ:MAT ). or Regal Entertainment Group (NYSE:RGC ) come to mind, if they enjoy going to the movies.
Watching the dividends flow into their accounts, or buy more shares through a DRIP plan could ignite their interest towards becoming serious savers and investors for their own future retirement, dividend growth style. Becoming a choice architect for good by nudging your own children can be very rewarding, indeed. The easier you make the choices, the easier you make it for them to invest online by opening the account and showing them the ropes, the more benefits you will both reap.
4. As can be seen from the above table of dividend pay dates, the FTG Portfolio now has 95 separate dividend payment events. If an investor constructs his portfolio in a similar manner, the frequency of dividend payments will provide another avenue for good choice architecture. The wealth effect for this investor will be an ongoing proposition, always feeding liquidity and dry powder into his account, enabling him to compound the growth of his dividends on a regular basis.
Dividend Growth and Income Just Works
Of course, there are many investing styles that investors have to choose from, and one is not necessarily better than another. But those investors who have come to utilize dividend growth investing have basically come to the conclusion that it is more predictable to invest in high quality companies with long histories of paying an ever-growing dividend payment, than it is to count on Mr. Market to determine the amount they have when they're ready to retire.
Dividend growth investing gives investors an easier glide path toward retirement that is tied to the earning success of their portfolio companies, and not to the whims of other investors, industry meltdowns that can take down their companies with it, occasional panics that deflate stock prices, and full blown market corrections that can lop off 20% to more than 50% of an investor's portfolio worth.
The DGI understands that his bottom line is focusing on growing the dividend stream over time. The ideal for such investors is to grow the stream to a point that when retirement comes, those dividend payments will fill the gap between what Social Security and other pension benefits might provide, and the income necessary for paying the bills over the course of your retirement.
Let's Look at the FTG Portfolio
Constructed beginning on 12/24/14, this portfolio now consists of 17 companies, including AT&T, Inc. (NYSE:T ). Government Properties Income Trust. Altria Group Inc. (NYSE:MO ). Consolidated Edison, Inc. (NYSE:ED ) , Verizon Communications Inc. (NYSE:VZ ). CenturyLink, Inc. (NYSE:CTL ). ConocoPhillips (NYSE:COP ). Main Street Capital Corporation (NYSE:MAIN ). Ares Capital Corporation (NASDAQ:ARCC ). Reynolds American Inc. (NYSE:RAI ). Vector Group Ltd. (NYSE:VGR ). EPR Properties (NYSE:EPR ). Realty Income Corporation (NYSE:O ). Sun Communities, Inc. (NYSE:SUI ). Omega Healthcare Investors (NYSE:OHI ). StoneMor Partners LP (NYSE:STON ) and W.P. Carey Inc. (NYSE:WPC ).
Dividend income has grown from $21,245.66 to today's $23,082.08. for an increase of $1836.42 in annual income, or an 8.64% increase in less than 6 months' time.
While the broad market continues to trade in a very narrow band over this time period, the FTG Portfolio has managed to continue gaining ground and surpassing income goals. This is the power of dividend growth combined with dividend re-investment.
Will You Be Nudged?
If, over your investment lifetime, you can allow yourself to be nudged into accumulating enough assets, you will have no problem having a comfortable retirement. The Fill-The-Gap Portfolio sports an overall current yield of 5.38%. If you were to subscribe to the 4% rule in retirement, it becomes clear that you could easily draw down 4% annually from this portfolio in dividends alone and your principal would remain intact. Your portfolio will have a surplus each year because the dividends paid are higher than your 4% drawdown.
The biggest fear investors have is that they will outlive their money and grow poor in retirement. Investing in this way, for dividend growth and income, chances are very good that you will not outlive your money. If you lived below your means during your working life, and do the same in retirement, you will not run out of money in retirement.
At the same time, the extra funds you do not need to draw could be easily reinvested and your account balance would always be growing as to the income it produces each year. This would afford you the ability to draw down a slightly larger amount if you desired each year to keep even with inflation and maintain your purchasing power. In this way, your portfolio principal need never be touched, leaving you the choice of bequeathing the principal to your heirs or your favorite charity.
This would constitute a very decent final choice for good, for all parties concerned.
The Bottom Line
Growth of annual portfolio income is our bottom line goal. Since 12/24/14 inception, we have consistently grown income through opportunistic purchases of shares when they were on sale, buying below fair value and buying when dividend yield was above 5-year averages. Using these and other portfolio management tools to better that income are basics that we employ and can be used by any DGI investor for better results.
For additional color as to how investors can redeploy capital gains to obtain higher income going forward, I invite you to read a recent article, "Retired Dividend Investors Are Deluded By Yield On Cost," which drew over 349 lively comments to date, and lots of interesting debate.
As discussed in the introductory article. the average two-earner couple can expect around $28,800 in annual Social Security income. To close the gap between a fairly comfortable $50,000 retirement income, this average couple needs additional income of $21,200.
We have suffered no dividend cuts or eliminations, and having enjoyed many increases in a very short time period, it is safe to assume we are currently in cruising mode, having surpassed our income goal and requirements quite rapidly.
For younger millennial investors willing to be open to ideas to further their financial education, this portfolio represents a solid foundation. For them, and all pre-retirees and retirees, this model of portfolio construction is offered as a foundational way to build retirement income for the future that addresses inflation head-on. The dividends in this portfolio will continue to grow in such a way that future income will not be degraded and decimated by inflation. On the contrary, purchasing power will be preserved.
The Fill-The-Gap portfolio for 2015 presents a new beginning, an opportunity for retirees, near-retirees and new, younger millennial investors to start the process of making their transition to dividend growth investing in some of the safest, most predictable, long-paying, high-payout companies in America.
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If you found this article, the concept and investment results interesting and intriguing, I invite you to read the other articles in this series. Stay tuned for further articles that will introduce additional sectors and names to further diversify a portfolio for continued ballast and mitigation of risks to any one sector.
Should you be interested in reading any of my other articles detailing various strategies to enhance your returns on a dividend growth portfolio, please feel free to find them here.
As always, I look forward to your comments, discussion and questions.
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.
Disclosure: The author is long ARCC, COP, CTL, ED, EPR, MAIN, MO, RAI, SUI, T, VGR, VZ.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.