Some things get better with age: wine, whiskey, a properly humidified cigar…
Other things, not so much…
Take my knees and rotator cuffs, for example. Against all better judgment, I joined an over-40 men’s basketball league. We had a game last night. We won, and I had a blast doing so. But I really wish I had iced my knees and shoulders after the game. I’m feeling the pain this morning. It’s worth it.
Rather than focus on my decrepit knees, I’d rather add another item to the list of things that get better over time: dividend growth stocks.
Dividend Growth Stocks
I enjoy a high yield as much as the next guy. That’s a major focus of my income newsletter, Peak Income. But focusing exclusively on yield exposes you to the risk of losing ground to inflation over time, which is exactly why I spend so much time in hidden corners of the market that offer investors a little more protection during tough times.
The Fed’s goal is to keep inflation at around 2%.
Now, we could split hairs about their calculation methods, and I think it’s fair to say that the “real” inflation rate experienced by most Americans is significantly higher than that. But let’s be generous and pretend the Fed’s 2% inflation target is reality.
Like interest, inflation compounds.
So, over 10 years at 2% inflation, your purchasing power will decline by 22%.
Over 20 years, it’s nearly 50%.
We’re talking about losing half your purchasing power over 20 years, even under a wildly conservative estimate of inflation.
While bonds, preferred stocks, and high-yield (but no-growth) dividend stocks might pay you a fantastic income stream today, you run the real risk of having your retirement standard of living degraded over its course.
Now, let’s compare that with a proper dividend growth stock.
A Proper Growth Stock
Realty Income (NYSE: O) is a REIT specializing in high-traffic retail. Think the local gas station or pharmacy.
The REIT raises its dividend 4% to 5% per year, and it’s working on a string of 89 consecutive quarterly dividends hikes.
Realty Income is not a particularly high yielder at today’s prices. It’s dividend yield is a modest 3.8%. But let’s imagine you bought the REIT five years ago. Your yield on cost — or the annual dividend today divided by your original purchase price — would be a much more attractive 5.7%.
Pretend you bought Realty Income 10 years ago; your yield on cost would be a whopping 11.9%.
Let’s get really crazy… assume you bought Realty Income 20 years ago. That would make your yield on cost a gargantuan 22.4%.
Yes, you’d be making more than 22 cents per year for every dollar you invested in Realty Income. That’s the power of dividend growth.
Now, I’m not recommending you go run out and buy Realty Income today.
Personally, I think the shares are a little too expensive to justify buying with new money. But I do recommend waiting for a significant pullback.
I bring this up to show you that there’s more to income investing than simply grabbing the highest yield you can find — something I’ve taken to calling “yield whoring.” I consider it a vice that’s detrimental to your financial health.
A good income portfolio should have a mix of high-yielding investments and lower-yielding but faster-growing dividend stocks. That’s the only way you’ll stay ahead of inflation in a long retirement.
If income investing is your thing, check out Peak Income.
In it, I look at both high-yield investments, as well as low-yield investments, that bring in a steady stream of income while diversifying our portfolio to minimize risk. It’s just the kind of thing you need to prepare, or better, your retirement.