Challenges with Dividend Investing for Retirement Income or

Even though I am a Registered Investment Advisor, opinions expressed in this article are in my personal capacity. I am not recommending any stock or any investment strategy, this article is just for information purposes. Please consult a qualified financial advisor to discuss your financial needs to develop an investment plan. You can feel free to reach out to me in case you need any help with your financial requirements. 

Although the primary objective of this article is to delve deeper into challenges faced with dividend investing for retirement income or financial independence, this article can provide useful information not only to retirees but to anyone who is interested in generating income through consistent and safe means be it a college student or a person who just entered the workforce or someone thinking about ways to earn side income to quit the daily grind of commute, boss and endless, useless corporate meetings.

Thinking about retiring or quitting the workforce early to devote time to something you really care about or are passionate about will surely require you to develop a concrete basis to replace your monthly salary with regular income. Let’s call this regular income “hafta”. Hafta is a Hindi word. In India, hafta means protection money paid to gangsters or corrupt government bureaucrats on a regular period. Hafta was frequent in India while I was growing up in the ‘80s and ‘90s and is not very common in today’s India. If a person owed hafta to a gangster or a government official, then “no matter what”, this person had to pay the set amount to go on with his daily life or face the wrath of gangsters with a broken limb or face severe official challenges through nefarious acts by government officials.   

I don’t mean in any way to offend anyone by equating regular income to hafta nor am I trying to justify the hardships faced by families due to evil deeds by gangsters or corrupt government officials. The sole objective to use hafta as an analogy to regular income is to drive home the importance of “no matter what”, the need to generate a regular income during retirement or financial independence. This regular income must be generated at consistent intervals, in a safe mannerwhich does not bear undue risks and should have the inherent characteristic of growing on an annual basis with minimal action on your part. 

Hafta: “No matter what” consistent intervals, safe manner, does not bear undue risks, growing on annual basis, minimal action on your part. Wow… is this even possible?

Even though there are multiple different ways to satisfy this tall order, dividend income can come close to hafta as one of the strategies to generate income consistently, in a safe manner without taking any undue risks and grow annually action with minimal on your part only if done correctly. However, based on my own personal journey as a dividend investor and by guiding my clients in this process I have realized that there are challenges to this fruitful process. These challenges, if not understood correctly, can discourage you from the path of dividend investing and may result in time and/or capital loss and in general develop a mistrust in stock market further alienating you from a niche community who have learned to navigate these challenges and lead a life full of happiness, peace and success while enjoying the consistent “hafta” for managing their yearly expenses.  

There are three major challenges to successful dividend investing:

Patience

Depending on your time horizon to retire or retire early, the amount of contributions made on a regular basis and varying amount needed to cover your annual expenses, the time to reach a point where all your expenses are covered through dividend will vary from person to person. Even though the time may differ for each person, let me be the bearer of the bad news; it will take a good amount of your working years. And when I say good number of working years, it can be a minimum of 10 years before you see any meaningful results. A minimum of 10 years…. Do you even want to think about something that may end up taking a minimum of 10 years of your working life in the day and age where geniusness is expected to be displayed in a 5 second reel or a thesis is to be presented in 140 characters or less? In short, do you have the patience for these number of years?   

Let’s take the example of Mr. Ramlal, who has $48,000 in annual expenses. For Mr. Ramlal to generate a dividend worth $48,000 annually, he will need to have $1,200,000 in dividend paying stocks. Further his portfolio should generate a dividend of 4% so that his goal to cover his annual expenses can be met. I don’t want to complicate this simple example by throwing in Mr. Ramlal’s annual salary or his savings rate or for that matter his regular contributions to his portfolio. Rather, to ponder upon the thought as to how long it must have taken Mr. Ramlal to reach a point where his portfolio swelled to 1.2 million dollars and his goal to achieve retirement or financial independence became a reality.  

Dividend cut risk

A publicly listed company can choose to reward its investors by distributing dividends. These dividends can be on a regular quarterly basis or can be one-off. Further this company can choose to increase the dividend distribution to its investors on an annual basis or keep it constant or for that matter choose to cut the dividend in half or completely. It is not unheard of a reputable publicly listed company to cut its dividend or stop paying dividends to its investors due to macro-economic trends or its own company specific financial issues. For example, Disney suspended its semi-annual dividend in July 2020 citing COVID-19 pandemic. 

Let’s get back to our friend Mr. Ramlal and assume he was paid by Disney $2500 semi-annually in the form of dividends. Mr. Ramlal’s dividend income was reduced to $43,000 due to this dividend cut. Based upon these new circumstances, none of them were the doing of his own, can Mr. Ramlal think of retiring if he had already announced his plans for retirement? Or worse, what if he had already retired or left his job in pursuit of his passion because of his newfound financial independence? How would he fill the void of $5,000 to manage his annual expenses, “go back to work…”?  

Capital loss risk

Capital in the form of your hard-earned money needs to be invested in publicly listed dividend paying companies to receive dividends. Apart from the real possibility of cutting dividends, your hard-earned capital is also at a risk of being wiped out partially or completely. This wipeout of capital can be due to multiple reasons, like incorrect decisions taken by the company management, macro, or micro economic risks to name a few. For example, Walgreens stock is a dividend aristocrat and has raised its dividend consecutively for the past 47 years, impressive! However, the stock price of Walgreens has taken a big hit in recent years and is down 46% from late 2019 and has lost more than two-thirds of its value since its high of 2015. 

Yeah, let’s go back to our dear friend Mr. Ramlal, and assume the value of Walgreens stock in his portfolio amounted to $50,000 by late 2019. His stock value in Walgreens would be worth $27,000 today which would make his portfolio $1,177,000. Even though Mr. Ramlal can meet his annual expense needs as Walgreens has not cut its dividend there is a real risk of this happening. Furthermore, if Mr. Ramlal had to switch Walgreens for another solid dividend paying stock, he would be at a material loss of $23,000 giving him less capital to invest in another solid dividend payer which may result in him not being able to meet his obligation of $48,000 in annual expenses.  

If you understand these three challenges in the right context and have a solid plan in place, then the journey of retiring or achieving financial independence within your time horizon can be comfortable and fun filling ride well worth to be taken to enjoy “hafta” while you dedicate your time to something that you are passionate about or really enjoy doing on a regular basis. 

In the next series I would like to write about specific strategies to overcome dividend investing challenges so that our community can have a more successful, rich, and abundant wealth creation process while enjoying the nuances of life without sweating about dividend cuts or capital risk.

If you liked this article, then please share it with your friends and family so that they can be educated about challenges with dividend investing for retirement income or financial independence.

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