“The income plan” was the headline in a special, full page, information ‘advertisement' in the Globe and Mail of June 17, 2009. The ad seemed to have been sponsored by, and probably was paid for by, Standard Life. I was curious to see how they were going to get income from a mutual or segregated fund, so I read the entire page. Our three week old grandson, beside me, was not yet stirring. Here are some thoughts I jotted down in the margins of the page. I'll compare the ideas outlined in this special information supplement to what dividend growth investors do as I go along. Ours is truly an income plan: theirs? Well, you decide. A lot of funds are trying to play the ‘income' card in their recent advertisements. Regardless of how they shuffle the pack, the income card is not in their deck. “In uncertain times, income is hard to beat.” was the headline, for instance, in the Dynamic Funds ad this spring. That's it exactly: and we dividend growth investors have the growing income. Dynamic offers a Strategic Yield Fund, which, they say in their ad, has a balance between fixed income, income-oriented equities and other income-generating investments.
”[T]ransitioning from asset accumulation to an income portfolio” they said in the first sentence, “can be daunting”. Daunting? That's poppycock! Transitioning is not daunting for those of us with a portfolio of common stocks. Upon retirement, we keep the very same dividend paying stocks. Instead of re-investing the dividends, however, we can spend the dividends. There is no reason to sell our assets at retirement. In fact, selling would be unwise. We build up our income generating assets (common stock) during our working years, just for this purpose, to generate income. Our dividend yields, by retirement date, will most likely be quite high and could even be double digit (an example below). Actually, here's where we have the big advantage over fund-based retirement plans. Because we do not need to eat into capital to fund our retirement, the value of the market on the date of our retirement is irrelevant. Our assets (common stocks) produce income…a growing, and often tax-free, income.
The special information supplement implied “creating an income that is sustainable and predictable what ever the financial markets do” was their intent. But how? Mutual funds, historically, have not generated much income. Conversely, many common stocks pay dividends: they really provide income every quarter. These wealth management types failed to convince me they are going to create income, going to get blood out of a stone. They twist their definition of income, to persuade people. For instance, they said in the ad that , “In some cases, these funds are paying as high as eight per cent to nine per cent of tax-efficient income.” They must be including capital appreciation as income. But gains are not income, not periodic. To obtain a spendable gain, you have to sell. Dividend growth investors do not have to sell to obtain income. Realize also, if you buy bonds through a mutual fund, you lose your guarantee of your money back at maturity. And further, would you want to buy a fund that was paying out that much? Could you be getting your own capital back? With government bonds paying just over three per cent, what are these funds investing in to get eight to nine per cent? You cannot obtain returns of this kind with investment grade bonds.
”[T]here are strategies that can increase the net income generated”, the wealth management person was quoted as saying. Well of course there are, but trotting this out has nothing to do with the products they are trying to sell. Income splitting, including pension income splitting, was mentioned. The tax angle always draws people in and makes them think the advisor has their best interests at heart. They continue: “For retirees in the highest tax bracket, almost half of interest income ends up going to the government.” That's certainly true: this is the reason our strategy uses Canadian dividends. Canadian sourced dividends can be tax free up to some $40,000 a year, depending upon the amount and other sources of your income. The special ad recommended “alternatives [to interest] such as tax-efficient pooled pension funds and dividend income funds”.
But with funds, though, you still have those two big problems. First, what if the markets are down when you retire? Markets collapsed in 2008. Second, mutual funds are not noted for generating income: the retiree could start off behind the eight ball. There are serious flaws in a fund-based income plan. What planners say often sounds right, but can end up being totally not in your best interest.
10 By paragraph ten they got to the main product they are marketing: “Segregated funds are another attractive option for retirees”. The attractive features of segregated funds were outlined. Certainly the guarantee of principal is the main selling point. “At the end of a certain period of time”, they say, “you will have at least your principal minus withdrawals, or market value, which ever is higher.” This line is catching a lot of people. The guarantee, however, is expensive: it will cost you dearly. And, it will be even more expensive after what happened to the markets in 2008. Again, there is no mention of income. Is simply getting your money back enough? In retirement, you want dependable income. Two thousand and eight, taught us capital appreciation is fleeting. This special advertising supplement ended by recommending pre-retirees consult an experienced advisor. Well of course they did: they want to peddle their products. “Consider the silent consequences” as Nassim Taleb says in The Black Swan (page 112), of sitting down with a financial planner.
The dividend growth alternative - a real income plan: Assume, while in your fifties, you bought a stock for $10 which pays a dividend of 50 cents each year. Your yield is 5%, right? Let's say the dividend is increased by 5 cents the next year. Your yield is now 5.5% as your cost is still $10 and the annual dividend is now .55 (that's .55 / 10 = 5.5). Suppose further that the dividend rises by 5 cents a year for ten years so that the dividend becomes $1.00. Your yield is now 10% ($1 / $10 * 100). Now, the long term historic return of the stock market is 9.7%. So with yield alone, after ten years, just counting the dividends, you are beating the market. We are not counting any increase in the stock's price here. This is what dividend investing is all about. Is the dividend guaranteed? No. But “with prudent selection, as well as patience, buying and holding stocks that steadily boost their dividends can produce income that's virtually impossible to find in other investments”. M. D. Weiss, The Ultimate Depression Survival Guide. As I see it, the dividend growth strategy is the real income plan. In 2008, with the markets reeling, our dividends increased 9.9% When was the last time you received a 9.9% raise. Over the last five years, the dividend-paying stocks I follow increased by 14.1% per year. Over the last decade, dividend growth was 14.8%, again per year. It's consistent. It's dependable. And the bonus, your capital will grow along with the dividend. Investigate dividend growth investing.
Standard & Poors September 8 2004 issue of Outlook, expressed it this way: “If you are planning to retire in 10 to 15 years, we think you should consider buying stocks that have long histories of dividend increases. While investors tend to look at the current yield (the indicated dividend divided by the share price) of a stock, we believe yield on cost (the indicated dividend divided by the per share purchase price) may be a more accurate measure of the long term value of a dividend.”
- Here's the essence of the problem with a fund-based income plan. This idea is from The Ultimate Dividend Playbook by Josh Peters: “One of the key themes of this book is the idea that dividends, through both yield and growth, enable investors to meet real-world financial needs directly with their portfolios. Fickle capital gains (green today, red tomorrow, endlessly unpredictable) do not”.