Answers to Three Critical Questions for Your Retirement
I get a lot of questions about how money invested for retirement should be allocated. Which kinds of stocks? Should dividends be reinvested? What if I have to start withdrawing money?
I’ll attempt to answer some of these questions today, but please realize I don’t know your personal situation, so this is general advice. If you have further questions, speak with a financial planner.
What Kinds of Stocks?
If you’ve read Wealthy Retirement for more than a day, you know I’m a huge proponent of dividend payers – but not just any stock with a dividend or high yield. I especially like Perpetual Dividend Raisers. These are stocks that raise the dividend every year.
There are currently 540 companies that have raised their dividends each year for five years or longer and more than 740 have done so for four years. So there are plenty of stocks to choose from.
Your portfolio of Perpetual Dividend Raisers should vary across size and industry. Large, mid and small caps should all be in the portfolio, as should financial, energy, REITs, consumer, telecom, technology and other sectors.
A portfolio of at least 10, but preferably 20 to 25, stocks will spread your risk across a wide variety of industries. Inevitably, certain sectors will be hot when others are weak. Having 20 to 25 holdings should ensure you have exposure to whatever is hot at the time, while minimizing the pain from the weak positions.
To Reinvest or Not to Reinvest
If you do not need the investment income that your dividends will produce for five years or longer, I strongly suggest you reinvest your dividends. It’s fine to do so if your time frame is shorter, but if it’s longer, it’s imperative that you reinvest those dividends.
By reinvesting your dividends, compounding will work its magic, and not only should your wealth increase, but the amount of income you will receive when you retire will be much higher.
If you invested $100,000 in a portfolio of stocks with a dividend yield of 4% and that dividend grew by 10% per year, after 10 years, your dividend income would be $9,431 if you chose not to reinvest the dividend.
But if you reinvested the dividends for 10 years and then collected the income in year 11, you would take home $14,404, or 52% more than if you simply pocketed the annual payout.
More impressively, your nest egg would be significantly larger.
If, during that decade, the funds were invested and the market behaved according to historical averages, the investor who does not reinvest his dividends would have a nest egg of $205,700, not including the dividends he collected during those 10 years.
The investor who reinvests the dividends has $317,774, over $112,000 more.
If you don’t need the cash that your dividend-paying stocks spin off, it’s almost always better to reinvest the payout.
Going Through Withdrawal
A common question that I get is how should money be invested that needs to be withdrawn. My answer depends on why the funds are being withdrawn.
If the money is being taken out because the investor needs it to pay the bills, then it should be converted to cash three years before it’s required. That doesn’t mean you sell the entire nest egg.
If the investor has $100,000 invested and will need $10,000 a year starting in three years, then she should sell $10,000 worth today, $10,000 next year, etc.
It will be frustrating to make next to nothing on the cash for the next three years, but it’s better than putting needed funds at risk.
What happens if the investor needs the money in the midst of a nasty bear market and the $100,000 is only worth $80,000? Now, $10,000 is taken out and the nest egg is only worth $70,000.
Better to know you’ve got the cash no matter what the market decides to do.
If the investor is taking the money out because Uncle Sam says he has to – IRA rules say investors need to start withdrawing retirement funds starting at 70 1/2 – that could be a different story.
If that investor doesn’t need the money – perhaps they have a pension or other income that pays the bills – then it’s OK to leave the money invested (other than what the law requires be withdrawn), perhaps even reinvesting the dividends.
Sure, there’s a chance that a bear market will reduce the amount in the IRA, but if the investor isn’t relying on that money to live on, he’s better off leaving the money in there to continue building for as long as possible.
Investing can be as complicated as you want it to be. Fortunately, investing in dividend stocks can be quite easy and extremely lucrative.