The 7 Keys of Dividend Investing For Retirement

I firmly believe a portfolio stuffed with boring, blue-chip dividend-paying stocks is one of the best ways for the average investor to ensure a prosperous retirement.

There are other variables to consider, of course. Your savings rate matters. So does your ability to buy during market downturns, rather than selling. And most investors will need to consistently buy over decades in order to have enough in dividend income for a luxurious retirement.

But these issues exist no matter what investing approach you take.

There are other effective methods, but many of them don’t hold a candle to dividend investing. Some investors will swing for the proverbial fences, putting their cash in risky stocks that don’t pay dividends. This can work during bull markets, but the pullbacks are downright nasty during bear markets.

Imagine looking forward to retirement for decades only to have it delayed because your portfolio took on too much risk as you approached that magical day.

Or imagine saving aggressively and putting your cash to work… only to see the market fall by 40% just about immediately after. Many investors can’t handle that, and they’ll pull their money out at the worst possible time.

This method has another obvious weakness — it requires investors to make sell decisions to convert their capital gains into cash, something most investors (myself included!) stink at.

Other methods investors use are indexing (which will often spit out dividends, which are then primarily used to cover living expenses, making it a quasi-dividend strategy anyway) and putting capital to work in mutual funds and other similar products that charge high fees for the comfort of steady income.

There are weaknesses to a dividend-focused approach too, but pound for pound I believe it is the best way to generate a dependable income stream for retirement. 

For today’s edition of the newsletter, let’s take a closer look at the 7 keys that make up the bedrock of my dividend portfolio, rules that have enabled me and countless other dividend lovers to build enviable portfolios that generate enough income to cover all our expenses… and then some.

I think you guys will find them helpful, too.

Diversify

They say diversification is the only free lunch in investing.

This is a principle I took to heart after making several concentrated bets in the 2012-14 period, when I was starting to really get interested in the stock market. These big bets almost universally didn’t work out for me.

All I can say more than a decade later is thank God most of my net worth was in real estate.

These days, my portfolio is much different. It consists of dozens of different dividend stocks. You don’t have to go that far either — the evidence is you don’t need more than 10-15 stocks to be properly diversified.

Here’s the way I look at it. I only get one shot at this early retirement thing. So I take steps to minimize my risks. One of the easiest ways to do so is to make sure my dividend income is coming from a large number of sources — just in case something goes wrong.

I wasn’t retired in 2020, but this attitude sure did help during that market downturn, when most of my dividend income stayed intact. I think it helps during the next crisis, too.

Buy good companies

Simply put, I want to own a collection of good dividend stocks.

Identifying quality companies is perhaps equal parts art and science, but here are some of the things I look for on this front:

• A history of solid performance

• A history of raising dividends

• A history of steadily improving profitability

• Conservative balance sheets

• Management with skin in the game (insider ownership)

• A history of good capital allocation

• Good returns on capital invested

Many investors try to identify a small selection of high quality stocks and then concentrate among what they consider the winners. I embrace a different attitude. I’m not confident in my ability to rank stocks in that way, so I diversify (there’s that word again) into a collection of what I view are good companies. I let everyone else concentrate into the best; I’m fine owning a collection of the good.

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With dividend growth

Dividend growth is a key part of my retirement. It ensures that my income stream gets larger over time, making sure it at least keeps up with inflation.

But there’s more to it than that. I want to stuff my portfolio with companies that are growing over time — since I know that higher earnings drive the share price up and to the right.

Dividend growth is the key, but it would be foolish to ignore capital appreciation completely.

Ultimately, dividend growth is a signaling mechanism. Earnings and dividends tend to grow hand-in-hand with each other. Thus, I can use dividend growth as a reasonable proxy for earnings growth. And if I choose a company with a long history of dividend growth, it’s a proxy for a company with a long history of earnings growth. That’s exactly what I want.

Yes, sometimes companies will hike their dividend without the underlying earnings growth to support it. That’s why I look under the hood and make sure there’s potential there.

I’m a value investor at heart, as you’ll see with the next rule, but I also firmly believe investors who ignore growth do so at their peril.

I’ll note I do own a few stocks without recent dividend growth — these are companies that should grow their payouts soon but perhaps have other capital allocation priorities right now. The bedrock of my portfolio, however, is in dividend growth.

For reasonable prices

This might be the most important part of this list, so pay attention. 

I don’t buy a single dividend growth stock until it hits what I deem to be a reasonable price.

I let everyone else chase the high flyers.

What I do instead is relentlessly research solid dividend companies. That way when one starts to struggle I’m already up to speed. All it takes at that point is a little refresher to see what’s happened lately, and I’m in business.

There are ridiculously easy metrics one can use to ensure you get a good price, too. You can scour the 52-week low lists. You can also look at historical dividend yields — a higher yield indicating good value. Or you can look at a company’s valuation and compare it to the recent past.

Personally, I love buying stocks that hit at least two of those three criteria.

What happens when you take this value approach is you’re naturally maximizing your dividend yield. But these value stocks also tend to perform quite well on the capital gains side, which adds a nice extra oomph to total returns. That’s a double whammy I can really get behind.

With sustainable payout ratios

One of the few things that keeps a dividend investor up at night is the dreaded dividend cut. 

This section will teach you how to minimize that risk, but you’ll never avoid it completely. Even the most carefully selected dividend portfolios will inevitably suffer a cut or two.

What you can do to minimize the risk of a dividend cut is to limit your exposure to companies that pay out virtually all of their earnings back to shareholders. This one little trick is the key to the whole exercise. 

Often, this will manifest itself in a slightly different rule, one that tells dividend investors to avoid anything with a high yield. I disagree with that. It’s the earnings that matter, not the yield.

For instance, on the premium part of the newsletter, we cover certain stocks that have high dividends, solid dividend growth, and safe payouts. Just recently we’ve looked at:

• A temporarily depressed growth-by-acquisition company with a 3.9% yield and a 20% payout ratio (based on free cash flow)

• A specialty finance company with a 6.5% yield and a 70% payout ratio, plus a demonstrated history of growing that payout over time

• Two different utilities that offer 5%+ yields and payout ratios under 50% of earnings

• A unique REIT that has grown earnings by 12%+ per year since its IPO, and pays a 4%+ dividend with a very reasonable payout ratio of < 50%

• A little-followed telecom that offers a 3.9% yield with a history of 8-10% annual dividend growth with a 35% payout ratio

These are all cheap on other metrics too, plus they have a history of solid returns.

I’m not advocating investors put all their eggs in the high yield basket. Far from it. All I’m saying is there are solid Canadian stocks that pay 5%+ dividends that still have reasonable growth potential. And we help premium members find them… along with a bunch of other solid stocks.

That aren’t risky

One key point I’ve been stressing on this newsletter for months now is that low risk stocks outperform their riskier peers.

This is something many investors dismiss, but it’s true. And it’s a phenomenon that has persisted over multiple decades and over just about every stock market in the world.

This research piece by Hillsdale Investment Management confirms it. Low risk stocks outperform, and do so while taking less risk.

Many dividend growth stocks are naturally low risk anyway. It’s the nature of investing in mature companies with demonstrated moats. They’re less likely to be disrupted.

Investors can further reduce their risk by sticking to conservatively managed dividend payers, and by looking for stocks that are less volatile than the market as a whole — which is measured by a stock’s beta.

This concept is why I’m all about boring stocks. They offer the perfect combination of sleeping well at night and solid returns.

For a buy and hold forever timeframe

Although it’s not perfect, I firmly believe most investors would benefit from a buy and hold forever attitude.

Firstly, as I mentioned off the top, most investors are bad at selling. They often buy high and sell low, or they invent some nonsense reason to sell one of their best performers.

As Peter Lynch so famously said, selling your top performers is akin to cutting the flowers and watering the weeds.

Plus, investing is best when it is most businesslike. Too many investors view stocks as pieces of paper that can be easily flipped for something more appealing. You’re buying a piece of an underlying business, and it often takes years to really see the benefits of that.

Dividends make it easy to hold for very long periods of time. After all, if the dividends are rolling in, the price doesn’t matter nearly as much. Especially come retirement.

The bottom line

To summarize, these are the seven key things I look for when buying dividend stocks:

1. Diversify

2. Buy good companies

3. With dividend growth

4. At reasonable prices

5. With sustainable payout ratios

6. That are a lower risk than the overall market

7. With a “never sell” attitude

It really doesn’t have to get more complicated than that, folks.

But most importantly, these rules help investors avoid many of the mistakes that can sink a carefully laid out retirement plan. Diversification ensures you don’t have too much in one stock. Insisting on a reasonable price will avoid many of the pitfalls that come from buying bubbly overpriced stocks.

Limiting your investing universe to stocks with sustainable payout ratios will help you avoid the dreaded dividend cut. And a never sell attitude will help you hold onto your winners — which is when the real compounding starts to happen.

The hard part, of course, is finding these stocks. We can help. Canadian Dividend Investing is a research service for busy DIY investors looking for Canadian dividend stock ideas.

Just $200/year gives you one of Canada’s top dividend investors in your corner. Twice a week I send you dividend stock ideas that can help you maximize your passive income, ultimately helping you retire richer.

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