CDUAF - Why Ignore Low-Yield Stocks When Planning Retirement?

2023-10-26 22:35:00 ET

Summary

• Why do people ignore low-yield stocks when planning retirement? In one sentence: because they complicate retirement planning.
• The more income you get from selling shares, the less dividend income you have to generate from your portfolio.
• Some investors think low-yielders are dangerous because their performance comes solely from stock price appreciation.

Why do people ignore low-yield stocks when planning retirement? In one sentence: because they complicate retirement planning.

Nobody wants to figure out how many shares to sell each year on top of getting their dividends, their pension income and other. “Low yield stocks don’t pay the bills”, or do they? Also, many investors think that retiring on low-yield stocks is dangerous.

Let’s explore these reasons for ignoring low-yield stocks to see if they hold water.

Low yield stocks don’t pay the bills

To assess this reason for ignoring low-yield stocks, let’s look at this scenario. You invested $10,000 in Alimentation Couche-Tard ( ANCTF ) ( ATD:CA ) and $10,000 in Visa ( V ) in 2013, both low-yield, high-growth stocks. In May 2013, you bought:

• 1,031 shares of ATD at ~9.70/share
• 222 shares of V at ~$45.05/share

Ten years later, those shares are trading at $66.01 and $231.30, respectively.

In 2013, you also invested the same amounts in AT&T ( T ) and Canadian Utilities Limited ( CDUAF ) ( CU:CA ), companies offering higher yields, and you reinvested their dividends to buy more shares.

Today, your portfolio is worth almost $150K… of which 123K, 82% of the portfolio value, is invested in the low-yield stocks. By selling a few shares as needed, these low-yielders pay the bills quite nicely!

I don’t want to sell shares to generate income

Why not? The more income you get from selling shares, the less dividend income you have to generate from your portfolio.

Continuing with our earlier example, imagine you retire today with these four stocks. You stop reinvesting the dividends, and you want to live off your dividends. Let’s look at your dividend income:

Interestingly, your low-yielding stocks generate $1001.67 and your high yield stocks generates $1,523.76. You see, Mike, high yield generates more income! I agree. In fact, it’s a little more than 50% more! However, I have $123K invested in the first two stocks and $27K in the high-yielders.

If you sell $523 of ATD to compensate (fewer than 10 shares), the following year, your ATD shares will generate 0.85% * 67,397 = $572.87 or ~$5 less than last year. That is, without considering any capital gain or dividend increases that might occur during the year.

You could probably repeat this operation for 100 years and still have money invested in both ATD and V. Conclusion: selling low-yield, high-growth shares has a small impact on the ability to generate the basic dividend.

One could argue that you could sell your ATD and V shares, and buy more of CU and T to generate a higher dividend income.

Last week’s article depicted the 10-year total returns of 12 U.S. and 12 Canadian high-yield stocks; 66.66% of them either cut their dividends or failed to increase them enough to cover inflation.

I don’t like those odds. This seems like the perfect path to eat a lot of peanut butter and jelly sandwiches and Kraft Dinner.

Retiring on low-yielders is dangerous

I need to address this point loud and clear. Some investors think low-yielders are dangerous because their performance comes solely from stock price appreciation. Again, last week’s article made it clear that low-yield, high-growth stocks offer protection rather than risk.

Companies that are growing their revenue and earnings by high-single to double digits attract investors. In doing so, the trend of the stock price remains solid.

The 24 low-yield stocks I picked in that earlier article show convincing results. But on top of strong performance, there are more advantages of investing in them.

Advantages of low-yield high-growth stocks

I’m a big believer in understanding why you hold shares of specific companies and understanding how these companies will contribute to your retirement plan. Let’s see why low-yield, high-growth stocks perform so well.

Exposure to the 5 factors

If you’ve done any research about market performance, you would have stumbled upon academic papers about the 5 factors that explain most of the stock market return.

Interestingly, many financial advisors or dividend investors pull out those studies to tell you dividends are relevant. According to them, dividend growth is a symptom of a strong exposure to the 5 factors:

• Market beta? Stocks that collectively have lower volatility than the broad market
• Size? Smaller, and more nimble companies
• Value? Stocks that are lower cost relative to their peers
• Momentum? Stocks that are outperforming and reduce exposure to stocks that are underperforming
• Quality? Companies with strong financials relative to similar cost peers

Source: BlackRock

I’d rather say that dividend growth is the result of thriving companies that are exposed to those factors. The odds of picking a high-yielder that is also a thriving company are slim. However, low-yield, high-growth companies usually check many of those boxes.

Long-term wealth preservation

It’s safe to conclude that thriving companies offer great protection for your portfolio. As these companies grow, their share prices increase. It’s just pure logic. Therefore, selecting high-quality companies with a generous dividend growth policy is a better strategy than selecting companies based purely on yield.

Sustainable income growth

I’m not telling you to build a portfolio with a yield under 2% after reading this. However, by adding a few low-yield high-growth stocks, you increase your chances that your portfolio income grows and beats inflation.

Let’s say you retire at 60 and need $50K income from your portfolio. Assuming inflation at 2.10%, you’ll need $68K from the same portfolio at age 75 and $84K at age 85. If your portfolio’s dividends aren’t growing at this pace, even 2% inflation could derail your retirement plan.

In a nutshell

Don’t ignore low-yield, high-growth stocks when planning your retirement. Include a few in your portfolio to benefit from their stock appreciation and the protection they offer against inflation.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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