By: Bruce Miller, CFP®
So far in this series of articles, we have discussed the important principles of pure income investing, its advantages, disadvantages and the mental discipline I consider vital to this approach for providing a reliable retirement income.
Now that we have a general idea about our overall strategy, we must identify the subset of publicly traded securities that will generate dividends reliably over the years and decades ahead. These are the dividends a retiree and his or her household will require over their retirement years.
However, what is the most reliable method for selecting the equities that meet our retirement income goals and how do we pick those equities from the thousands of available choices?
An income security is any corporate stock, corporate bond, shares of an exchange-traded fund (ETF), real estate investment trust (REIT), units of a master limited partnership (MLP), mutual fund – closed end or open end – shares or other investment vehicle. Any type of equity for which you can buy shares or units that you believe will be able to provide you with a long-term dividend is a candidate for inclusion in the retirement income portfolio.
The goal of the quest is to find reliable dividend income securities that will provide a sufficient level of income over the desired period. Of course, none of us can see the future or know its unexpected twists and turns. After discussing the first two dictums for retirement income investors in a previous article, it is time to add the third dictum of the pure income investor.
Dividends are predictable with high confidence while share price is not.
Were this dictum not true, pure income investing simply would not work. This raises the question of why are income security dividends so predictable? The answer to that question comes down to two fundamental reasons:
- The security is required to pay out dividends or interest to its shareholders.
This requirement might be either due to tax structure of the security or because this is the agreement the company has with its shareholders and a failure to pay out a dividend could lead to legal or administrative regulatory action that would not be in the company’s best interest. Examples here include REITs, Preferred Stock, Business Development Companies, Bonds and mutual funds. I will explain each of these examples in future articles.
- The security is subject to the ‘invisible hand’ of dividends.
Strong forces drive many large companies to pay regularly increasing dividends to their shareholders. While these dividend distributions are completely discretionary to the company’s Board of Directors or the general partner of a master limited partnership, consider that during the past 25 years more than 100 companies have paid a quarterly dividend that has grown EVERY YEAR. These companies continued to boost their annual dividend amounts despite a couple of deep recessions and the periodic need for those cash flow dollars to support capital expenditures and growth elsewhere in the company. If you ever wondered why that was the case, I will explain my theory in another article.
Right now, I want to keep my focus on identifying the criteria that make a reliable dividend. What are those factors that let us predict, with such accuracy, that this or that income security will continue to make reliable dividends? In the next few articles I will go over some of the criteria every investor must consider to select the equities that best match the goal and structure of an investor’s portfolio.
While many criteria can be used for identifying suitable securities for retirement income, I will first go through what I consider to be the most important screening criteria. In the next article, I will focus on the dividend yield and then go over the other criteria – dividend history, dividend growth rate, the nature of the business that the security represents and dividend coverage.
Bruce Miller is a certified financial planner (CFP) who also is the author of Retirement Investing for INCOME ONLY: How to invest for reliable income in Retirement ONLY from Dividends and IRA Quick Reference Guide.