High Stock Dividends: A Competitive Retirement Income Solution
By: C. Thomas Howard, PhD, CEO of AthenaInvest, the sub-advisor to the AdvisorShares Athena High Dividend ETF (DIVI)
Sufficient yield, keeping up with inflation, and outliving the funds available are three major concerns facing investors who are building a retirement portfolio. A high dividend yield equity portfolio can provide a competitive approach to addressing each of these concerns.
Potential Higher Income and Inflation Hedge Relative to Bonds
A high dividend yield equity portfolio has the potential to produce 2 to 3 times the income per dollar invested in comparison to a traditional low risk bond portfolio. This means a much smaller portion of your portfolio has to be dedicated to income generation. In addition, dividend income grows over time while bond income remains the same. Unlike the income provided by a high risk bond portfolio, dividends grow over time at a rate likely to exceed the inflation rate. Not only do you start with more income per dollar invested, but the dividend income stream will likely provide an inflation hedge.
Higher Dividend Yield, the Higher the Portfolio Return
Research shows that the higher the dividend growth rate and the higher the dividend yield, the higher is the total portfolio return. The market myth that higher yielding stocks produce lower total portfolio returns has been repeatedly rejected over the last 100 years by the evidence.
Not only do dividends grow over time, but so does the principle, even if all dividends are paid out and not reinvested. At the overall market level, research shows that the higher the dividend growth rate and/or the higher the dividend yield, the higher is the subsequent total portfolio return.1 More specifically, research reveals that dividend yield is a good predictor of future earnings growth, so a period of rising dividend yield bodes well for future market returns. At the individual stock level, too, dividend payout and yield are predictive of future earnings growth and future returns. Among other things, this body of research has found that dividend changes contain information about 1) future earnings that cannot be found in other market data, 2) company profitability, and 3) future positive earnings surprises.
Most companies pursue a policy of growing dividends over time, however every once in a while a company reduces its dividends. Researchers have found that companies increase dividends 60% of the time, keep them unchanged 36% of the time, and reduce them only 4% of the time. That is, increasing/unchanging dividends outnumber decreasing dividends by 27 to 1. Thus a high dividend yield portfolio can outpace a traditional low risk bond portfolio on both dividend yield and growth as well as on principle growth.
International Holdings Adds Diversification and Potentially Higher Yields
There is a diversification and a yield advantage for including both US and international stocks in a dividend equity portfolio. These two asset classes have less than perfect correlation, while international stocks tend to pay a higher dividend. It is also possible to change the weighting between these two based on return expectations in the two markets. Approximately 67 percent of the world’s dividends come from outside the U.S., according to MSCI, so adding an international component to the dividend equity portfolio increases the selection of stocks, and potentially the yield as well.
Stock Selection Process – A Patented Approach
AthenaInvest has a patented behavioral research process which looks at the high conviction stocks held by the best U.S. and international active equity mutual fund managers.2 Sector, strategy and country diversification are used to reduce risk, as selections are made from these top relative weight positions. From this pool, a diversified portfolio of high yield global stocks can be built. While most equity dividend funds focus on dividends first and stock selection second, Athena applies its patented behavioral approach to stock selection in the first step.
Both yield and return can be further enhanced by dividend yield and expected return weighting the portfolio. The expected return weights are based on the expected returns in both the US and internationally, with larger weights for the higher expected return market.3
Short-Term Volatility Shouldn’t Impact Dividend Stream
The one downside to a high dividend yield equity portfolio is short-term price volatility. But stock price volatility little impacts the dividend stream as firms follow a stable or growing dollar dividend policy and very infrequently reduce dividends since this has a dramatic impact on the stock price. In addition, the short term volatility disappears as downward price movements are more than offset by upward price movements over time. Thus principle grows over the long run.
If you’re concerned about the risk of outliving your money and seeking an income stream, you may want to consider a dividend equity solution. Since both dividends and principle grow over time, on any future date you will likely be receiving more income and be sitting on a larger principle. This is in contrast to a fixed income portfolio in which the best you can hope for is a level income stream and the same principle over time. A high dividend equity portfolio provides value for a retirement income solution.
1 See “Surprise! Higher Dividends = Higher Earnings Growth” by Rob Arnott and Cliff Asness in the Financial Analyst Journal, Jan-Feb 2003, and “On the Importance of Measuring Payout Yield”by Jacob Boudoukh, et al., The Journal of Finance, April 2007.
2 This can be accomplished by limiting the pool to the highest relative weight stocks held by strategy consistent, high conviction active equity mutual funds. AthenaInvest has strategy identified all US and international active equity mutual domiciled in the US (about 2800 in total), which allows for objectively measuring each fund’s consistency and conviction. Based on the relative equity holdings for those funds displaying the largest values on each of these two measures, a high conviction stock pool can be created.
3 Visit athenainvest.com for details regarding the expected market return methodology.