Building a Dividend Retirement Portfolio: A Real-Life Story

Many of us are managing dividend portfolios designed to deliver safe retirement income.

 

I oversee our Conservative Retirees dividend portfolio, which is designed for people living off dividends in retirement.

 

Safe dividends, income growth in excess of the rate of inflation, and low volatility are some of the main goals of any retirement portfolio.

 

I have had countless discussions with all sorts of dividend investors about how they became involved with dividend investing and how they approach building a dividend retirement portfolio. Every story and approach is unique and usually provides a few new tidbits of wisdom.

 

Most recently, I connected with Dividend Sleuth, a popular author on Seeking Alpha who has been investing in stocks for 35 years. He is in the same boat as many of us and was kind enough to share his journey as a dividend investor as well as his current dividend retirement portfolio. I expect you will gain a few new investment ideas and potentially even a new perspective on how to construct your portfolio.

 

Here is his background, as seen on Seeking Alpha:

 

“I’m a 65-year-old investor focused on dividends in a Retirement Income Portfolio. I’m not yet in the distribution phase of retirement.

 

I’ve been a member of the National Association of Investment Clubs (NAIC) since 1982, which now operates as BetterInvesting.org. For many years as a volunteer I helped lead workshops to teach tools developed by NAIC to educate investors about how to do basic fundamental stock analysis. I continue to have a strong interest in investor education.

 

NAIC’s historic “four principles” have been very helpful to me:

 

1) invest regularly throughout your lifetime;

2) invest in growth companies;

3) reinvest earnings and profits;

4) diversify by industry and size.

 

Bill Bengen’s “4% Rule” concept inspired me to set a goal to create a retirement income portfolio of individual dividend growth stocks as a way to tap only dividend income from the portfolio as long as possible rather than selling assets.”

 

Without further to do, let’s learn about Dividend Sleuth’s path to dividend investing.

 

My Journey as a Dividend Investor

My experience with individual stocks began in late 1981, when I was invited by two older colleagues to help form a new investment club. Our first meeting was in February, 1982, when the Dow Jones Industrial Average was around 800 (Brian’s note: the Dow Jones now sits above 18,000 – talk about the power of long-term compounding). I remained a member of the club for over 23 years until it disbanded in 2005.

 

Our club was part of the National Association of Investment Clubs, which was formed in 1951 to provide tools for stock study and suggestions for stocks to study through their Better Investing magazine. The organization is now called Better Investing.

 

The study of public companies and their stocks became my primary hobby and for several years I was a volunteer instructor at NAIC workshops, using an overhead projector (later PowerPoint) to teach investors how to use NAIC’s stock study tools.

 

NAIC (now BI) developed a tool called the Stock Selection Guide, which plots on a semi-logarithmic graph 10 years of earnings per share, company revenues, pre-tax profits, dividends and price range.

 

This data provides the basis for estimating a possible high price and low price during the next 5 years. Through public libraries we accessed either Value Line or Standard & Poor’s Reports to find data for the prior ten years. Now, this information is available online from betterinvesting.org and the Stock Selection Guide is computerized.

 

I am grateful for my early grounding in fundamental stock analysis provided by this organization. As an individual investor, I continue to serve as a director of the Alabama chapter of Better Investing.

 

Since 1951, the focus of NAIC/BI has been growth stocks, with 4 principles for investing. The principles have changed slightly with time and today are:

• Invest a set amount regularly;
• Reinvest earnings, dividends and profits;
• Invest in quality growth stocks and equity mutual funds;
• Diversify your investments.

Even though the focus of my early years as an investor was on growth stocks, I’ve always had a healthy appreciation for dividends. The Stock Selection Guide includes an estimate of the dividends that will be received in the next 5 years and this calculation is added to the stock’s expected price appreciation to provide an estimate of total return. From my earliest days as an investor, I recognized the importance of dividends.

 

One of my favorite early stocks was a New Plan Realty, a real estate investment trust. Though no longer a public company, it was at one time was the largest REIT in the United States. This REIT was in our club portfolio and I purchased shares for my IRA.

 

During New Plan’s best years (1980s and early 90s), the trust increased its dividend each quarter. REITs do not pay federal income tax if they distribute at least 90% of their income (more on REIT taxation here), and I realized very early that this gives REITs a 35% “head start” over tax-paying corporations.

 

Around 2007, at age 56, I began to give more thought to retirement and how I might use my 20+ years of investing experience to provide supplemental retirement income.  I created a file folder for “Retirement Planning,” and began clipping retirement-related articles from Better Investing, Forbes, Fortune, Barrons and the Wall Street Journal.

 

One of those articles was by Bill Bengen, who developed the “4% Rule,” which suggested a target distribution of 4% of one’s retirement account during the first year of retirement, with the goal of growing the corpus and continuing to draw from dividends and capital gains.

 

Dividend stocks were always well represented in my portfolio, but after reading Bengen’s article (and others’ commentary about it), I decided to focus 100% on dividend stocks, with the goal of assembling a diversified portfolio that yields about 4%. Prior to the distribution phase, I would reinvest dividends to grow the IRA.

 

My plan, at least in the first years of retirement, was to limit distributions to dividend income (to avoid selling securities). I was aware that tax law requires minimum distributions (RMD) from IRAs beginning at age 70.5, and this would eventually necessitate the sale of some securities, but that was (and still is) several years away.

 

Some retirement planners speak of income “buckets” or perhaps a “three-legged stool” as a way of describing different income sources for retirement. I have made contributions to Social Security since the early 1970s, so that is one potential “bucket.” I am scheduled to begin receiving Social Security benefits in December, 2016, when I reach age 66, which Social Security considers my “full retirement” age.

 

I retired in 2010 after 40 years as a pastor. I am very fortunate to have a pension as a result of those years of service. I began making voluntary monthly contributions to my pension account in 1975, when the pension plan was modernized to allow such contributions were.  I began receiving pension benefits from this “second bucket” when I retired in 2010.

 

In 2010, I rolled some of the pension money to my IRA (more on using dividend stocks in IRAs here), which provided a nice boost to this “third bucket.” In anticipation of this rollover, in 2008, I set up what I called a “dummy portfolio,” though I eventually changed it to a “model portfolio” with the value I expected to roll over.

 

Let’s say it was $100,000. I determined which new stocks I would purchase with that amount. This was a very helpful exercise. I treated the model portfolio just like it was actual money and I would make buy and sell decisions “on paper.” Most of the buying and selling was the result of fluctuations in the value of the rollover amount. If you were in the market in 2008-2010, you will remember that fluctuations were extraordinary during what came to be called the Great Recession.

 

Some of my friends delayed retirement because of the bear market, but I decided to stay with the plan, and the model portfolio gave me the confidence to do so. As the market value of my expected pension rollover decreased with the declining market in late 2008 and early 2009, the value of the stocks I had targeted for purchase also decreased—usually in the same proportion. It was “a wash.”

 

When the pension rollover amount increased, my target stocks increased. Throughout these relative ups and downs, I noticed that my projected dividend income did not fluctuate with market price. The stalwart dividend companies continued to raise their dividends regardless of market price fluctuations.

 

So, I retired in mid-2010. After a brief break, I began working part-time. I took some IRA distributions from 2011-2014.  I have continued to work part-time (which has provided a “fourth bucket” that I and many retirees have utilized).

 

Also like many other retirees, I enjoy my “second career” work and the fourth bucket it provides. The upcoming addition of Social Security income will provide additional flexibility to cease working at whatever point seems appropriate.

 

I do not plan to resume IRA distributions as long as I’m working. I have established some short term and long term goals for IRA income, and the strong bull rally of 2016 has enabled me to make good progress toward those goals.

 

My Dividend Retirement Portfolio

My current retirement portfolio consists of 38 individual equities, 4 exchange traded funds, 6 closed-end funds, 8 preferred stocks and 4 “baby bonds.”

 

Almost all of the time spent on portfolio management is devoted to the 38 individual equities, which comprise 65.7% of the portfolio and contribute 57.2% of the portfolio’s income.

 

Table Key

S&P: the corporate credit rating by Standard & Poor’s, where available.

Yrs: the number of consecutive years of dividend increases.

Price: as of October 12, 2016.

%Port: the percentage of the total portfolio comprised by each holding.

Div: the annual dividend.

%Inc: the percentage of the total portfolio’s income contributed by each holding.

Basis: is the cost basis for each security.

 

The bull rally that followed the lows of February, 2016, enabled me to book some gains and re-deploy those funds beyond individual equities. I added the preferred shares and bonds when the equity market was near all-time highs to reduce volatility and to “lock in” some yields around 5%. I realize there are no “locks” with the market, but it seemed prudent to diversify into some other assets with common stocks near their highs and dividend yields near their lows.

 

Here are the 8 preferred stocks, which comprise 13.0% of the portfolio and contribute 17.6% of the portfolio’s income. Headings are the same as above.  S&P is the agency’s rating for the preferred security.

 

Issuer	Ticker	S&P	Price	%Port	Div	Yield	%Inc	Basis
Schwab	SCHW.D	BBB	26.94	1.5%	1.49	5.5%	2.0%	26.29
CHS Inc	CHSCM	NR	27.17	1.5%	1.69	6.2%	2.3%	26.74
Fed Ag Mtg Corp	AGM.C	NR	27.50	1.5%	1.50	5.5%	2.0%	26.35
KKR LP	KKR.A	BBB	26.68	1.5%	1.69	6.3%	2.3%	25.95
Public Storage	PSA.B	BBB+	25.94	2.8%	1.35	5.2%	3.6%	25.38
State Street	STT.G	BBB	26.58	1.4%	1.34	5.0%	1.8%	26.58
Tri-Continental	TY.P	NR	52.00	1.4%	2.50	4.8%	1.7%	52.65
Wells Fargo	WFC.Q	BBB	26.38	1.4%	1.46	5.5%	2.0%	26.31
				13.0%			17.6%

 

Here are the 4 bonds, sometimes called “baby bonds,” which trade like preferred stocks. These bonds, all issued by utilities, make up 5.4% of the portfolio and contribute 7.0% of the portfolio’s income:

 

Issuer	Ticker	S&P	Price	%Port	Int	Yield	%Inc	Basis
Entergy N Orleans 1st Mtg	ENO	A-	24.63	1.3%	1.38	5.6%	1.9%	26.26
Entergy Arkansas 1st Mtg	EAI	A	24.63	1.3%	1.22	4.9%	1.6%	24.92
NextEra En Cap Jr Sub Deb	NEE.K	BBB	25.27	1.4%	1.31	5.2%	1.8%	25.34
Southern Co Gas Cap Jr Sub	SOJB	BBB	24.93	1.4%	1.31	5.3%	1.8%	24.98
				5.4%			7.0%

 

I added some non-leveraged closed-end funds selling at discounts to net asset value. Most of the CEFs write options to generate income. The CEFs boost the yield and provide further diversification (learn more about investing in CEFs here). Several of the CEFs are sector funds and one focuses on Berkshire-Hathaway holdings (see analysis of all of Warren Buffett’s dividend stocks here).

 

Here are the 6 CEFs, which comprise 5.8% of the portfolio and contribute 12.3% of the portfolio’s income.

 

Table Key

M*: the Morningstar rating, where available.

NAV: the fund’s net asset value.

Disc: the discount of the price to the NAV.

Dist: the current annual distribution.

 

Fund	Tick	M*	Price	%Port	NAV	Disc	Dist	Yield	%Inc	Basis
Boulder Gro & Inc	BIF	3*	8.15	0.9%	10.24	20.4%	0.40	4.9%	1.1%	8.38
BlackRock Util & Infr	BUI	3*	18.93	1.0%	19.38	2.3%	1.45	7.7%	1.9%	18.46
Cohen & Steers TRR	RFI	3*	12.57	1.0%	13.60	14.2%	0.96	7.6%	1.9%	13.00
Tekla Wld Health	THW	NR	14.52	1.0%	15.47	6.1%	1.40	9.6%	2.3%	14.01
EV Tax-Mg Div Eq	ETY	3*	10.71	1.0%	11.32	5.4%	1.01	9.4%	2.4%	10.40
EV Risk Mg Div Eq	ETJ	1*	9.39	0.9%	10.14	7.4%	1.12	11.9%	2.6%	9.83
Total				5.8%					12.3%

 

I also added some exchange traded funds to begin laying the framework to perhaps shift from individual equities to funds (investors can learn more about investing in dividend ETFs here). There may be a time when I am no longer interested in managing a portfolio of individual equities, or am no longer physically able to do so. This would also provide an easy option for my heirs if they do not want to manage a portfolio of individual equities.

 

My goal is to eventually hold 7 ETFs. Three are aimed at gaining exposure to the broad US market through the Vanguard Total Stock Market ETF (VTI), to the developed world ex-US through the Vanguard Developed Markets ETF (VEA), and to the emerging markets through the Vanguard Emerging Markets ETF (VWO). My target allocation is for VTI to be 25% of the ETF total, VEA to be 20% of the ETF total, and VWO to be 5% of the ETF total.

 

To provide some enhanced dividend income, my plan is to add four other ETFs: the Vanguard High Dividend Yield ETF (VYM), the Vanguard REIT ETF (VNQ), the Vanguard Mid-Cap Value ETF (VOE), and the Vanguard Utility ETF (VPU). My target allocation is for VYM to be 25% of the ETF total, VNQ and VOE to each be 10% of the ETF total, and VPU to be 5% of the ETF total.

 

At this point, I have added 4 ETFs:  VEA, VWO, VNQ and VPU, which make up 7.1% of the portfolio and contribute 5.9% of the portfolio’s income.  For the three that are on my watch list (VTI, VOE and VYM), I’ve included my target buy price in the “Basis” column below (see Brian’s top 10 dividend ETFs here).

 

Fund	Tick	M*	Price	%Port	Dist	Yield	%Inc	Basis
Vanguard Total Stk	VTI	4*	109.09		2.04	1.9%		102.00
Vanguard Dev Mkt	VEA	4*	36.55	1.0%	1.02	2.8%	0.7%	37.56
Vanguard Em Mkt	VWO	3*	37.45	1.0%	0.89	2.4%	0.6%	35.00
Vanguard Hi Div	VYM	5*	71.21		2.18	3.1%		70.32
Vanguard REIT ETF	VNQ	3*	82.80	2.3%	3.53	4.3%	2.4%	86.88
Vanguard Mid Val	VOE	5*	91.81		2.49	2.7%		85.72
Vanguard Utilities	VPU	3*	103.54	2.8%	3.30	3.2%	2.2%	109.60

 

Currently, 3.0% of the portfolio is in cash. The portfolio yield is 4.05%. The market value is up 19.0% year-to-date.

 

Closing Thoughts on Managing a Dividend Retirement Portfolio

I enjoyed learning more about Dividend Sleuth’s dividend retirement portfolio and found many similarities between his dividend stocks and my own. By my calculation, his portfolio’s Dividend Safety Score is in excess of 80 (very safe), and most of his holdings are blue chip dividend stocks.

 

He clearly places a high weighting on business quality and focuses on companies that have demonstrated an ability to consistently grow their dividends each year. He owns many Dividend Aristocrats and Dividend Kings, and he has made sure to keep his portfolio nicely diversified with reasonable position sizes and exposure to a number of different industries.

 

Mixing in a select group of preferreds, baby bonds, and closed-end funds helps raise his portfolio’s current income generation, but these are just one part of his overall portfolio. Staying balanced, focusing on quality stocks, maintaining reasonable expectations, and executing a simple strategy that is easy to follow and aligned with one’s risk tolerance are all keys to responsible investing – whether for retirement income or long-term growth.