Growing the Nest Egg? Why this is the wrong metric to look at. February 7, 2010Posted by shaferfinancial in Finance.
Tags: where financial planning went wrong, why you should pay a?ttention to dividend yield
I have mentioned this before, but thought I should expound on this more directly. Since the 1980s and the constant push for mutual funds, financial experts have zeroed in on the capital appreciation of one’s retirement funds as the most important metric. That type of thinking has coincided with the drop in average dividend yield for the market. It is now down below 2.5%. The pre-1980 average was 5%. What the “how large is your nest egg” question has accomplished, is to bifarct the real question from the investment strategy. The real question is how much annual income your retirement funds can produce. What that creates are the contortions financial planners put their clients through [ie pull out rates ranging from 2% to 5%] as their total portfolio value varies [sometimes dramatically] from year to year. How financial planning can be accomplished with any rigor under this system is highly questionable.
Prior to this push for mutual funds and the corresponding items like risk adjusted rate of returns, asset allocations, average rate of returns, etc., investors kept their eye on the dividend and interest income being produced. This was a much more accurate way to measure retirement income.
So where does all this leave the average investor trying to save for retirement income? The first thing needed is to start thinking of income and not capital growth. The second is to realize that dividend income from corporations comes from free cash flow made by the businesses. This cash flow is then returned to its owners in the form of dividend income. Finally, since you are no longer trying to match the market capital growth returns you can begin to analyze businesses on the basis of their income stream paid out to their owners. Here it gets rich with possibilities because you will find that there are companies that have paid out increasing dividends going back 50-60-even 80 years. You will also find that some companies will sell you their stock directly, even giving you a discount in some cases. This will reduce your expenses. Finally, with just a little work you will learn how to evaluate companies and will be able to keep up with a half a dozen companies with just a little bit of your time.
What I have done is create a spread sheet that produces yields from my investment dollars and total income. It doesn’t get any easier than that. Every month I know how much income my dividends produce and what the yield is on my investing dollar. When the market bears take over, my dividends remain the same [if I have picked wisely] or even rises. And that makes me sleep easier at night!