Wall Street and its marketing machinery is working overtime to develop new products that will be accepted as the industry’s solution for increasing retirees’ income. Unfortunately, many of the new financial services industry income products are overly complex, not clear as to their real value, or are merely variations of traditional insurance or annuity products. But, from an advisor’s perspective, there is an even larger issue with the design and implementation of these new products — they attempt to assume the role the advisor traditionally fills with the client. In other words, these new managed income products may become your next competitor.
The Opportunity It is well known that investors will pay premium prices for perceived value. Clients of financial advisors will no doubt pay premium prices for the design and implementation of a truly unique method for solving their income needs. They will also be deeply appreciative if the strategy is one that is transparent, understandable and easily monitored. One of the strategies that meets this challenge is simply a portfolio of dividend-producing stocks. I see a tremendous opportunity for financial advisors to become proactive and learn to build their own diversified dividend portfolios that have the potential to increase dividends (income) and build track records by using many of the funds that are already in the marketplace.
To initiate a discussion of this opportunity with your clients, you should begin with a simple explanation of why now is an excellent time to own a portfolio of dividend-producing stocks. For example: Imagine that you invested $10,000 in the S&P 500 back in 1973. You would have earned only $336 in dividends, or about a 3.36 percent return. Let’s say you held the index continuously for the next 33 years, and spent only the cash dividends each year. By 2006, the cash dividend alone would have grown to $1,859, or a yield of 18.59 percent on your original investment… without reinvestment or hocus-pocus.
Even though the current yield of the S&P 500 is not as high as it was in 1973, the yield is now higher than it was just a few years ago when it was experiencing a historical low of around 1 percent.
The Rate of GrowthWhat’s more important, however, than the initial current yield, is the rate of growth of the actual dividend being paid. Over those same 33 years, the dividend that started at $336 and ended at $1,859 actually grew at an average annualized rate of 5.32 percent, which is far in excess of the increase in the cost of living. I can’t think of a simpler, better solution to the long-term retirement income needs of baby boomers.
It is entirely possible for you to build your own diversified portfolios that have the objective of increasing dividends over time. These portfolios can be built with individual stocks or mutual funds that have historically increased their dividends over time.
This rediscovery of old-fashioned traditional values and strategies may come just in time to provide one solution to the biggest challenge facing millions of retiring baby boomers.
The Good NewsCompany directors have more recently focused on the components of shareholder returns. These returns have always included cash-dividend distributions based on real cash earnings in addition to anticipated market appreciation that may or may not ever materialize. With corporate earnings and return on equity continuing to expand (even in light of the current economic slowdown in real estate and financial companies), boards of directors appear to be becoming more willing to pay out cash earnings in the form of dividends.
This conservative attitude also leads to stronger balance sheets, greater capital adequacy, higher levels of surplus cash, and a surprise. The surprise is that companies with higher dividend-payout ratios have generated higher earnings-growth rates over time. Hence, not only is there the potential for higher income streams, but with higher growth rates there also is greater potential for added capital appreciation opportunities.
Avg. Subsequent 10-Yr EPS Growth
Starting Payout Quartile
One (Lowest Payout)
Four (Highest Payout)
Source: Arnott and Asness
The Bad NewsRecently, two investment sectors historically known for paying out high dividends have experienced economic and financial challenges — the financial sector and the real estate sector. What is interesting, however, is that while these sectors have historically paid out a higher percentage of their earnings as dividends with their stocks exhibiting some of the highest yields, their rate of dividend growth (or potential for increasing payout ratios) has been limited even in good times.
The Highest U.S. Yield Stocks are Found in a Few Sectors
Top 100 Dividend Yieldsin Russell 1000 Index
Top 100 Dividend Yieldsin Russell 2000 Index