Should Retirees Really Try To Live Off Of The Dividend Income?

Many retirees express the desire to “live off of the income”. They want to create a portfolio that provides enough income and income growth to fund retirement needs, without the need of selling shares. Obviously, if a retiree wanted to spend 4.5% of total portfolio value, they would need a total portfolio yield of 4.5%. They would also need some income growth if they want to adjust spending needs in line with inflation.

A dividend growth investor might be more than challenged to create a portfolio that generates a 4% plus yield. If we look at the US High Yield Dividend Growth indices, we see yields in the range of 3%. From the Schwab website, here are the yield details for the Schwab U.S. Dividend Equity Fund (SCHD).

And here is the yield offered for Vanguard’s higher-yield offering, from the Vanguard site, for the Vanguard High Yield Dividend Fund (VYM).

Of course, the two fund companies apply some quality screens in the attempt to find more sustainable income and income growth. As I have suggested in the past, it might be worthwhile for investors to check the indices to see if their companies have passed the dividend health screens. We can have a look or cross reference against professional analysis at no cost. As is often written, we, Indexers and Index skimmers, are freeloaders.

Here are the top 10 holdings from SCHD:

And here are the top 10 holdings from VYM:

You can go down the list of top holdings into the top 20 and top 30, and you’ll see that the funds have considerable overlap. I doubt that there will or be little difference between the two fund offerings over time. Courtesy of, here’s the comparison of VYM as Portfolio 1 vs. SCHD as Portfolio 2. The time period is the inception date of SCHD from November of 2011 to end of August 2016. We see a slight edge of VYM due to some slightly lesser volatility and drawdown. The Sortino ratio (risk adjusted returns are slightly higher). Of course, past performance does not guarantee future returns. Past dividend payments and dividend growth are not guaranteed to repeat.

We see though that the historical income is slightly higher for VYM over SCHD. The following chart represents the income with dividend reinvestment – accumulation stage:

The starting yield for VYM in 2012 was 3.57%. The starting yield in 2012 for SCHD was 3.13%, according to portfolio visualizer. The next chart shows the income without dividend reinvestment – the decumulation or retirement funding stage:

There would have been no need for a retiree to stretch for yield to get the portfolio to an initial 4% or 4% plus yield. The Portfolio grew into the 4% yield quite quickly. That is the magic of dividend growth when things are working to your favour. In 2014, VYM was already delivering a 4.2% yield on cost. SCHD was at 4% yield on cost. In 2016, both funds are approaching 5%. That retiree is getting some incredible raises. That retiree can spend more or collect a cash pile if the income is surpassing spending needs. Heck, they can take the surplus and reinvest the income into those higher-yielding dividend payers.

If, in 2012, that retiree wanted to spend at 4% of portfolio value, he or she would have only needed a very modest cash pile or bond component. As an example on a $ 1,000,000 portfolio with a $ 40,000 spending need (4% spend rate), that retiree would only have needed just over $ 4,000 of cash or bond sales. A $ 10,000 cash pile would have been more than enough to cover the $ 4,000 dividend income shortfall in 2012 and $ 1,100 shortfall in 2013.

Now I am not suggesting for a moment that a retiree enter retirement with only a 1% cash or bond component. From my observations, most retirees appear to hold a very considerable cash and bond component. The above scenario is during a more than favourable start date for a retiree. There has been no major market correction or recession, and there has been considerable stability in the dividend payers that have consistently increased their dividends over time. Retirees have to prepare for the times of stress when the portfolio value and portfolio income might face incredible challenges.

Here’s VYM from January of 2007 through to the end of 2016. We are displaying the income without dividend reinvestment.

The initial yield in 2007 was not quite as generous as present, at 2.7%. It fell to 2.1% in 2010. We did not have dividend growth; we had dividend distress and falling income. It did then recover and increase to 4.1% in 2015. In the above scenario, a retiree would have had to fund up to $ 19,000 in 2010 from non dividend sources. The cumulative cash shortfall from 2007 to end of 2014 is $ 97,700. Now keep in mind, that the market meltdown of 2008-2009 was a major market correction with the S&P 500 falling by 52% according to portfolio visualizer. We may or may not get another market correction of severe proportions. All said, we should prepare for worst case scenarios.

Also, it’s possible that an investor in 2007 might have constructed their portfolio had they avoided the hardest hit companies that were largely housed in the financial sector. That investor might have experienced consistent dividend growth through the recession and we would see more of the income growth scenario displayed in the first income chart for VYM and SCHD for the 2012 to 2016 period. On retirees searching for stability, here’s my recent article The Lowest Volatility Sectors For Retirees.

My readers will know that I appreciate the historical success of adding some bonds and more specifically longer-dated treasuries (TLT) to help in those periods of stress. Here’s how TLT performed in the recession from January of 2008 through the end of 2010.

We see the desired inverse relationship between the stocks and bonds, with the bonds offering price appreciation capital gains opportunity. That retiree could have sold TLT units to plug the income shortfall. Keep in mind that past inverse relationship does not guarantee a future inverse relationship.

And once again, if a retiree has created a portfolio that is delivering dividend growth year over year, the unit harvesting or share harvesting needs decrease every year as the dividend can potentially grow to eventually cover all spending needs. We will use Kimberly-Clark (KMB) as a portfolio proxy. The company is well, a staple within the Consumers Staple (XLP) sector.

Here’s KMB benchmarked against VYM for income for the period of 2007 through to the end of 2011, a five-year period, based on a starting portfolio value of $ 1,000,000. KMB is Portfolio 1. VYM is Portfolio 2.

KMB started the period with a yield of 3.1% and grew that yield to 4.1% in 2011. Even if a retiree held no bonds or cash, this is what the share harvesting scenario would have looked like. For this model, the retiree will be harvesting 4% of portfolio total value. For this example, we will not adjust for inflation. As a backdrop, here’s the dividend history as per the F.A.S.T. Graphs site. For the funding scenario from 2007 to end of 2010, I will use the dividends as per F.A.S.T. Graphs and for share price harvesting. I have used the historical share prices as per Nasdaq. The portfolio begins with a hypothetical $ 1,000,000 and hence 15,338 shares.

Year Dividends Share Harvesting $ Shares sold Share count
Initial 15338
2007 $ 32516 $ 7484 (66) 113 15225
2008 $ 35322 $ 4678 (67) 70 15155
2009 $ 36372 $ 3628 (50) 73 15082
2010 $ 39816 $ 184 (61) 3 15079
2011 $ 42221 0 0 15079

As we can see, the share harvesting did not damage income. In fact, the actual dividend income increased each year even with the share count reduction, courtesy of that dividend growth of course. The number in parenthesis in the shares sold column represents the share price for that share harvesting. Shares were sold in the week preceding the beginning of the next calendar year.

Modest share harvesting does not have to decrease portfolio income. With that realization a retiree would not have to necessarily skip over the Kimberly-Clarks of the world just because the company or basket of companies does not meet current income needs. That retiree might be able to add companies of higher quality and stability but with lesser current yields.

Perhaps there is an unwarranted fear of share harvesting? If a retiree can potentially build a higher-quality portfolio by allowing for lesser yields, that share harvesting need would potentially decrease retirement funding risks, not increase risks.

Seeking Alpha author Eric Landis started a series on creating a 4% plus current income portfolio in today’s environment. You’ll find the first article in that series in Yes, You Can Still Build A 4% Yielding Portfolio In Today’s Environment. You can follow that series and see that the portfolio has already experienced dividend disruptions and portfolio dividend growth has stalled out of the gate. And today’s environment might be qualified as a rip-roaring bull market.

I welcome your comments. Thanks for reading. And always please know and invest within your risk tolerance level. Always know and understand all tax implications and consequences.

Happy investing.


Disclosure: I am/we are long BCE, TU, TRP, ENB, BNS, TD, RY, AAPL, BLK, BRK.B, JNJ, PEP, CL, MMM, MDT, ABT, LOW, NKE, CVS, WBA, UTX, QCOM, TXN, MSFT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Dale Roberts is an Investment Funds Advisor at Tangerine Investment Funds Limited a subsidiary of Tangerine Bank, wholly owned by Scotia Bank; he is not licensed to provide professional advice on stocks. The opinions expressed herein are Dale Roberts’ personal opinions relating to his experience as an investor and are not those of Tangerine Bank or its subsidiaries and/or affiliates. This article is for information purposes only and does not constitute investment advice or an offer or the solicitation of an offer to buy or sell any securities. Past performance is not a guarantee and may not be repeated. Investment strategies are not suitable for everyone and you should always conduct your own research or speak to a financial advisor.