I hope to fund part of our retirement costs with dividend income. That’s led me to invest in a few dividend paying ultra-low risk stocks over the past few years. When I bought each position, I thought about the dividend yield it was offering and whether it seemed reasonable compared to the interest yields available from fixed income investments. One thing that became obvious was that dividend yields tend to be fairly low at the time of purchase considering the amount of risk you’re taking by investing in the stock market. I do own one blue chip stock, though, that is currently paying me a dividend only yield of 17%.
Percentages Can Be Deceptive
One thing I’d like to warn you is that you can’t live off percentages.
You may have a stock that is paying you a 7% annual dividend. That sounds great. Your bank account is probably only paying you 1.35%. And your one-year GIC is probably only paying 1.65%. At 7% you must be cruising, right?
Well it depends on how much money you have invested at that 7% yield. If you only have $1000 of that stock, your actual take home income is $70 a year before taxes. It’ll pay the high speed internet bill for one month, but it won’t pay the winter’s natural gas bill.
What Is the Real Percentage Yield?
I started this by mentioning I have a stock that’s paying 17%.
It would be more appropriate to say it’s paying $336.53 a year.
The percentage yield is very deceptive.
The initial investment in the stock was $1946.25.
In theory, that could mean the dividend yield for this stock is 17.2912%.
But is that realistic?
Present Day Dollars are Not the Same as Past Dollars or Future Dollars
To calculate a more realistic yield, I think I would have to change the value of the initial investment into “today’s” dollars.
For example, if I spent $1000 on January 1, 2012, that would be comparable to having spent $1012.38 on January 1, 2013. I could have purchased more for the same money a year ago because inflation was less. Or I could have purchased the same amount a year ago for less money because inflation was less. (I used the Bank of Canada Inflation Calculator for this example.)
So what would the cost, $1946.25 be in December 2013 if I had to buy those shares then?
According to the Bank of Canada calculator, it would have cost me $2880.64 to buy the same shares in 2013 that cost me $1946.25 all those years ago.
Out of curiosity, I also poked around the internet and found a couple of US inflation calculators.
According to data from Oregon State University and a calculator at http://www.davemanuel.com/inflation-calculator.php, if I was talking USD, the $1946.25 would be $3338.34 in 2013 dollars.
According to the calculator at http://stats.areppim.com/calc/calc_usdlrxdeflxcpi.php, it would be $2997.53 or using CPI data $3 325.39.
Why is there a difference? Because it depends on what values you use for the inflator/deflator.
The actual value doesn’t worry me too much. What I’m trying to point out is that the dividend yield would be more realistic if I divided the payment of $336.53 by $3 338.34, not $1946.25.
So what is that reduced yield? 10.08%
Why It’s Worth Buying Dividend Paying Stocks That Routinely Increase Their Dividend
The yield of 10.08% on this stock is still pretty good.
If I bought more shares in the exact same company today, I’d only get a 2.22% dividend yield.
At the time the first dividend was paid a few years after the shares were purchased, the yield was 0.15%.
You can see that the dividend has increased significantly over the years. In fact, unless I’m screwing up my math again, it has increased faster than the rate of inflation.
If a stock increases its dividend at a rate greater than inflation, and if I buy that stock when the dividend yield seems reasonable, then I consider the purchase to be similar to buying an annuity. Provided I keep that stock (and the company continues to prosper) I can receive a steady income stream that keeps up with or exceeds inflation.
Obviously buying stocks is much more risky than buying an annuity:
- any company can fail
- a dividend can be reduced or eliminated without warning
- a company can decide to stop increasing a dividend without warning
- if you sell shares of a company you can lose capital
However, unlike an annuity, my money is not actually locked in. If I pay attention to the business fundamentals for the company, and if I’m lucky, I can sell a stock that begins to under perform and buy something else. I may lose capital by doing this!
On the upside, though, I may also find my stock appreciates in value. If so, I can sell part of my stock and use the capital gains to invest elsewhere or to spend. (Of course if I sell the stock I will stop receiving the dividend: it’s that Goose that lays the Golden Eggs thing all over again.)
Is Buying Dividend Paying Stocks a Good Retirement Plan?
I honestly don’t know. It’s part of my strategy but certainly not all of it. I have
- a big chunk of money in fixed income (and because I am extremely risk averse it is a very big chunk);
- another big chunk of money in “buy the entire stock market” ultra-low fee ETFs
- a small amount of money in individual dividend-paying ultra-low-risk stocks
At this point, I would say only my future “vacation for a week somewhere further south than Timmins” retirement money is invested in individual stocks. I can forgo the annual vacation in retirement if I have to. I can’t forgo eating.
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Do you invest in individual companies that pay a steadily increasing dividend to investors? Do you ever check what your “real” yield is? Do the dividends help fund your retirement or do you hope they will some day? Please share your views with a comment.