The Social Security Administration reports the average monthly benefits payment to retirees is just a smidge over $1,500. That’s not a bad start, but for most people, that’s not going to cover all the bills we hope we’ll be able to incur in our golden years.
The good news: It doesn’t take a terribly big nest egg to add a $1,000 supplement to that monthly figure through dividends. Assuming an average yield of around 4%, a $300,000 portfolio of dividend stocks could do the job. The trick is simply putting the wheels in motion now for a better later.
To this end, here’s a four-step process for maximizing your dividend income in retirement.
1. Now: Start with a calculated plan
Later: Update that plan every year
It seems obvious, but many investors don’t flesh out a retirement savings plan with actual numbers. Sometimes they’re afraid they’ll learn they’ll never be able to retire, and other times they’re afraid such a plan will be too complicated. But investors need not fear. The fact is, it may take less than you think to fully fund your golden years, particularly if you start saving while you’re young.
Here’s some encouraging data: As a rule of thumb, you need only a stash of about 10 times your current salary to maintain your standard of living later in life.
That’s not chump change for the average middle-class investor, but it’s certainly not out of reach. If you’re in your 20s and 30s socking away a modest 10% to 15% of an average income in a retirement account, annual returns of only 9% will get you well past $300,000.
2. Now: Prioritize growing your nest egg
Later: Shift toward income-oriented dividend payers
Assuming you’re still working now, don’t crimp your capital growth by focusing on maximizing current income. Prioritize growth of your portfolio here with reliable growth stocks like Microsoft (NASDAQ: MSFT) or Shopify (NYSE: SHOP). Microsoft pays a modest dividend, but as with e-commerce support outfit Shopify, its overarching goal is revenue growth driven by reinvestment of profits in businesses that are growing faster than the overall economy.
This won’t be the case forever. As your retirement date nears, you should be gradually swapping out growth stocks for relatively weaker reward potential (relative to risk) with income-oriented dividend payers. Names like Verizon (NYSE: VZ) and The Southern Company (NYSE: SO) come to mind. The former is of course a telecom company, and the latter is a utility outfit. These business models are well suited to pay reliable dividends because their customers pay their bills just as reliably.
And once you’re in retirement, it might not be a bad idea to build a portfolio of predominantly dividend-paying names.
3. Now: Reinvest the dividends your income stocks are dishing out
Later: Turn your DRIP off
So you own a few dividend names even though you’re in your 30s and don’t actually need the income right now? That’s OK. Just make sure you’re maximizing the returns these lower-risk holdings offer by reinvesting those dividend payments in the same companies dishing them out through what’s called a dividend reinvestment plan, or DRIP. The difference between doing so and not doing so can be significant.
Take investment bank JP Morgan Chase (NYSE: JPM) for example. The value of just the shares themselves has grown an average of a little less than 13% per year over the course of the past 10 years. Assuming you reinvested its dividend payments in more shares of the stock, though, your average annual return improves to nearly 16%. During that decade the value of JPM shares more than tripled without dividend reinvestment, but more than quadrupled when dividend payments were reinvested.
There’s nothing magical about DRIP plans, to be clear. You could do just as well (or even better) by not reinvesting those payments in their payers and then investing that accumulated cash in something completely different. But dividend reinvestment plans offer built-in buying discipline when most investors are distracted by too many other things.
You don’t have to sell these stocks upon retirement, either. Just turn your dividend reinvestment program off and accept dividends in the form of cash.
4. Now: Automate your additions
Later: Don’t stop adding as long as it’s feasible to do so
Finally, if you’ve not done so already, automate recurring deposits into your brokerage or retirement accounts.
As with DRIP plans, there’s no voodoo or financial witchcraft with automated withdrawals from your paycheck into your portfolio. It’s just a way of establishing disciplined contributions when it would otherwise be easy to skip a month, or two, or several. Investors often don’t do it because they fear they might need access to that cash, though they rarely do. The thing is, it doesn’t take long at all to start seeing these withdrawals as you see your monthly water bill or rent payment. And if you do need it for an emergency, it’s not impossible to get to it.
If you’re still nervous, start small and build up. Committing just $100 per month to the market isn’t game-changing, but once you see you can live without that amount, it’s easy to ramp that figure up to $250 and even $500 per month. At that latter pace, an investor could build a $300,000 nest egg in just around 20 years with merely average returns.
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Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. James Brumley has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Microsoft and Shopify. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.