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Two older men look gleefully at their retirement dividends

The Value of Dividends in Retirement?

Thornburg Investment Management
1 Apr 2020
7 min read

Over the past 87 years, dividends have accounted for over 40% of the total return for the S&P 500 Index. Don’t underestimate the importance of dividends.

Executive Summary

  • Longstanding “all growth” or “all income” schools of thought about funding retirement need to shift to approaches that combine the two.
  • An investment strategy generating attractive current income and which provides an opportunity for dividends to grow over time can generate both long-term savings and fund current income needs for retirees.
  • The most effective dividend growth portfolios tend to widen their net to include companies outside the U.S., where companies prefer to return cash to shareholders through dividends, rather than U.S.-style buybacks.

Since 1900, dividends have accounted for approximately 45% of the total return for the S&P 500 Index. The importance of dividends is an often overlooked part of   investing, but should be top of mind as baby boomers prepare for retirement and look for high and growing income-generating investments.

There are generally two schools of thought regarding how best to fund expenses in retirement. There are many who believe a total return approach is optimal, whereby an asset allocation and total return is targeted for the portfolio and a portion of the retirement assets is sold periodically to cover expenses. While this approach attempts to provide the growth that retirees need to outpace the effects of inflation, they may also be forced to sell assets at an inopportune time.

The second school of thought follows a high-income approach, whereby the portfolio is comprised of high-yielding income investments in an attempt to generate sufficient current income to cover expenses. This approach can leave a retiree with limited opportunities to grow spending power and at risk from the ravages of inflation.

In this paper, we will examine a third approach, which is a hybrid of the total return and high-income approaches. We will explore how investing in stocks of companies that provide both high and growing dividend income can benefit a retirement portfolio undergoing the duress of withdrawals. This type of investment strategy has the potential to generate a growing income stream as well as capital appreciation needed by retirees.

Understanding Yield

When reviewing income-generating alternatives, retirees often focus on current yield (the current income divided by the current price). This works well for fixed income investments, which are contracts that pay a certain level of income to the bond holder each year and then return the principal amount at maturity. However, for equity investments, where both the income and stock price may appreciate, looking solely at current yield can disguise the growth in the actual dollar amount of the income generated.

To illustrate this point, figure 1 shows a comparison of bond yields versus equity yields over calendar years. At first glance, it is obvious that current yields on bonds are higher, but this higher yield comes with little to no potential for growth.

Figure 1 | Bond Yields versus Dividend Yields Calendar Year Yields

Source: Bloomberg and Standard & Poor’s
Dividends were not reinvested. Data through December 31, 2020. You may not invest directly in an index.
Past performance does not guarantee future results.

To show the difference between the growth of income provided from bonds versus a dividend-paying equity investment, in figure 2, we calculated the amount of income generated annually on a hypothetical $1 million investment made in 1990. While the income from the bond investment steadily declined from 1990 to 2020, the amount of dividend income derived from the dividend-focused equity allocation grew fairly steadily. Although beginning at a relatively modest level compared to the bond investment, the dollar amount of dividend income generated surpassed the bond income in approximately 10 years and ended at 912% of the bond income by 2020. For this example, it was assumed that the bond interest and stock dividends were being used to support expenses and not being reinvested.

Figure 2 | Bond Income Versus Dividend Income

Annual Income from a Hypothetical $1 Million Investment Made in January 1990
Source: Bloomberg and Standard & Poor’s
Dividends were not reinvested. Data through December 31, 2020. You may not invest directly in an index.
Past performance does not guarantee future results.

Total Return for Dividend Growers

Our analysis uses the S&P 500 Dividend Aristocrats Index, a subset of the S&P 500 Index. It is comprised of U.S. companies that have consistently increased their dividends for the past 28 years. Since the Dividend Aristocrats Index began in January 1990, we can compare its returns versus the S&P 500 Index for the period beginning January 1, 1990, to December 31, 2020, to determine its performance in a dividend-focused retirement portfolio, from a total return perspective. For the results, see figure 3.

Figure 3 | Dividend Aristocrats Index versus S&P 500 Index

Dividends were reinvested. Data from January 1, 1990, through December 31, 2020, annualized.
Past performance does not guarantee future results.

The total return for the Dividend Aristocrats Index of 11.97%, compared to the 10.21% return for the S&P 500 Index, is very attractive for investors of any age, not just retirees.

This test period included some very different investment environments, including the banking and real estate crisis of the early 1990s, the “internet bubble” in the mid- to late-1990s, that culminated with the 2000–02 bear market, and the maelstrom in the financial markets that began in late 2007. Figure 4 illustrates how dividend paying stocks performed during these difficult market scenarios, the 25-year period is segmented into five-year periods, the five-year period 2015- 2019, and finally the 29-year period is shown in its entirety.

Figure 4 | Dividend Aristocrats Index versus S&P 500 Index

Reflects reinvestment of dividends. Data through December 31, 2020, annualized.
Past performance does not guarantee future results.

As the analysis in figure 4 illustrates, the Dividend Aristocrats Index outperformed in four of the five five-year periods. It only underperformed during 1995–1999, when investors were infatuated with high-growth stocks that fueled the internet bubble and led to the 2000–02 bear market.

While the Dividend Aristocrats Index didn’t keep pace during this period of “irrational exuberance,” they produced an attractive total return of 19.48% and proved far more resilient when the bubble popped.

Dividend Income in Retirement

To illustrate how a dividend-grower strategy can be used to fund a retiree’s expenses, figure 5 assumes a hypothetical $1 million investment in the S&P 500 Dividend Aristocrats Index beginning in January 1990. To calculate the retiree’s spending, we assume that 5% or $50,000 will be needed to cover pre-tax expenses in the first year of retirement and then increase that amount annually by a 3% cost-of-living adjustment to cover inflation. For the early years in retirement, when  dividends  don’t  fully  support the spending, the retiree will redeem a portion of the investment to cover the shortfall. For the later years, dividend income, beyond what is needed for spending, was reinvested in the portfolio.

Figure 5 | Dividends for Retirement Income from S&P 500 Dividend Aristocrats Index

Source: Bloomberg and Morningstar
You may not invest directly in an index.
Past performance does not guarantee future results

In this hypothetical, the Dividend Growers Portfolio generated sufficient dividend income to cover 100% of  the  retiree’s  spending after seven years. Once this 100% coverage was achieved, it never fell below that level and generated excess dividends that could be reinvested into the portfolio. As summarized in the table below the graph in figure 5, the initial $1 million investment produced $4.03 million in dividends of which $2.50 million was spent and $1.53 million reinvested. The portfolio value, as of December 31, 2020, was $15.6 million.

For most retirees, developing a growing dividend income stream should be an attractive alternative to the total return or high-income approaches described earlier. Having the retirement portfolio generate sufficient income to cover expenses while the portfolio is poised with an opportunity for continued growth should be a goal for every retiree.

Best Practices

Before implementing a dividend-grower strategy, there are two improvements that should enhance the portfolio’s diversification and selection of attractive dividend opportunities. First, it may improve results to look for companies around the globe that offer both a high and growing dividend, rather than limiting the investment universe to just domestic stocks. As seen in figure 6, dividend yields outside the United States, are higher across more sectors. Allowing the construction of a more diversified income portfolio. Internationally, there is an equity culture where dividend growth is seen as a sign of financial strength and the tax structure does not incentivize returning capital to shareholders through buybacks.

Figure 6 | Dividend Yield by Country (2021 Estimates)

Source: MSCI indices sourced via Bloomberg as of June 30, 2021
Past performance does not guarantee future results.

Another benefit of using a global approach is the opportunity to improve the portfolio diversification by industry sector. In the United States, attractive dividends are typically concentrated in real estate and utilities. Outside the United States, dividend opportunities exist in a multitude of sectors, as shown in figure 7.

Figure 7 | Global Dividend Yield by Sector (%) (2021 Dividend Yield Estimates)

Sources: MSCI indices sources via Bloomberg as of June 30, 2021
Past performance does not guarantee future results.

The second improvement when implementing this dividend-growers strategy would be to use an active investment management team that chooses investment opportunities based upon fundamental research. The decline of dividends for U.S. companies in the S&P 500 Index since 2008 has made for a difficult environment, and even the Dividend Growers were not immune. It is important to use an active manager who can analyze both a company’s willingness and ability to pay a high and growing dividend as a way to try and navigate around some of the dividend declines seen in the broader market.

As the baby-boomer generation progresses on the road of retirement, a dividend-grower strategy may be a prudent addition to their equity portfolios as part of a core investment strategy. Not only can growing dividends  help  contribute to the retiree’s distributions, but the portfolio value may also have the ability to outpace inflation through price appreciation.


Following this strategy does not guarantee sustainability of a retirement portfolio or better performance, nor does it protect against investment losses.

Investing outside the United States, especially in emerging markets, entails special risks, such as currency fluctuations, illiquidity, and volatility.

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