How I Used Dividend Stocks to Create My Own Pension

I know many people who stay at a job they don’t particularly like for one big reason — the pension.

I’m amazed at what a powerful motivator a pension is. On the surface, the appeal is simple — income for life. But once we dig a little deeper it becomes clear that there are some significant downfalls as well.

Many of these employees work for the government, which is known for underpaying their people. This means in many cases these folks are limiting their total compensation by holding out for that pension.

They’re also making massive contributions to their pension, something that depresses their take home income for decades. Naysayers tend to forget this, only focusing on the match from the employer. But most companies tend to offer RRSP contribution matches, too.

The problem with this situation is when these folks yearn for more. They want to quit their job and explore the world, spend more time with their family, or start their own business, but they just can’t take the risk. The appeal of the pension is just too high.

Then there’s the other side of the coin — folks who would kill for their own pension, people who constantly worry about their retirement savings won’t be sufficient to fund their dreams of winters in a warmer climate, too much golf, or spoiling the grandkids. They view a pension as the ideal, something that would take all the worry about of retirement.

But here’s the deal. The dirty little secret of every pension is they are all stuffed with the same kind of boring dividend stocks we talk about on this newsletter every week.

You can build your own pension. It isn’t that hard, either.

I realized this years ago, and started building my portfolio with such a future in mind. I stuffed it full of boring dividend payers in sectors like telecom, real estate, utilities, and banks, among others. I patiently waited until these blue-chip stocks got cheap, and then I pounced.

They weren’t all winners. I bought some duds along with the good stuff. I did a bit of yield chasing and put too much emphasis on value when I should’ve focused on a stock’s moat a little more.

But even though I made these mistakes (and more), I built my own pension and retired from the corporate rat race in 2022. I’ll soon celebrate the two-year anniversary of when I quit my job (a holiday in my house) and my retirement is going great. I get to write about stocks all day long, with long breaks for travel, hobbies, and time with the people I care most about.

My income grows each year too, as the underlying stocks churn out steadily higher dividends. Exactly how I designed it.

Let me take you inside the main concepts I used to build my pension portfolio, boiling down a complex topic into three easy timeless lessons that helped me form the bedrock of early retirement.

It’s all about the income

A common criticism I get from more growth-oriented investors is I should focus more on total return and less on dividend income.

This is really easy feedback to ignore for a number of different reasons.

Firstly, we’re playing different games. They’re looking to maximize their dollars and take pretty substantial risks to do so. I’m in constant capital preservation mode as I worry about not screwing things up.

These are not the same thing.

Or, as Warren Buffett once so eloquently said:

I’m constantly reminded that I only have one shot at this early retirement thing, and a big risk is screwing things up by being too aggressive.

Besides, I know that my conservative portfolio will still deliver solid total returns over and above the dividend income because these companies still grow the bottom line each year.

They’ve done so for decades, and they’ll continue to do so for decades more.

And an ever-increasing bottom line will ensure the dividend income keeps up with inflation, too.

Take a boring dividend stalwart like Royal Bank (TSX:RY), which is widely regarded as the finest bank in Canada. Shares grew from just over $30 each in 2004 to more than $150 each as I write this, plus they paid generous dividends the whole time. That’s enough to turn a $10,000 investment into something worth more than $107,000 — assuming dividends were reinvested.

That’s a 12%+ annual return, which is downright excellent. Especially for a “boring” stock like Royal Bank.

Oh, and that investment would churn out nearly $4,000 per year in safe, dependable income, too. Not bad for a $10,000 investment 20 years ago.

Want another example? Rogers Sugar (TSX:RSI) has been a comfortable member of a cozy duopoly for decades now. It’s in an industry that doesn’t grow much faster than GDP, and it produces a product that most of us are trying to cut back, not consume more.

Rogers pays one of the sweetest dividends out there (sorry, couldn’t resist), and only delivers minimal capital gains. Yet it has still delivered solid total returns if you reinvested those dividends along the way.

This shows the power of a consistent dividend. Rogers shares only went from $4 each to $5.74 in the last 20 years. That works out to just 2% per year in capital gains. But that’s to Rogers’ dividends — which don’t even grow that much over time — the investment turned out pretty well.

These safe, boring, blue-chips offer the best of both worlds for someone looking to build their own pension. The dividend income is secure, especially if you use diversification to minimize your exposure to one name. And they also tend to deliver solid and steady total returns as small capital gains combined with dividends really add up.

Speaking of diversification…

Spread your risk

In a world where individual investors, traders, and hedge funds like to concentrate their portfolios in large tech stocks — you know which ones — it’s often difficult to advocate for a diverse portfolio.

After all, those folks are making great returns. Concentration seems to be working for them.

At least until this week, anyway.

But when it comes to building your own pension, we must remember that we’re playing a completely different game than the rest of the market. 

The concentration advocates will tell you that there are only 10 stocks worth owning, or some other such nonsense. I firmly disagree. There are plenty of stocks worth owning in Canada alone, and hundreds more in markets like the United States, Europe, Asia, and Australia.

For instance, my pension portfolio contains shares of both Grupo Aeroportuario del Centro (NYSE:OMAB) and Grupo Aeroportuario del Pacifico (NYSE:PAC), which both have concessions to operate Mexican airports for the government. These are excellent businesses that should grow at a steadily pace over time as Mexico’s economy improves and its citizens can afford to fly to more destinations.

And they pay generous dividends too. According to Yahoo Finance, OMAB pays an 8.3% dividend. PAC’s dividend isn’t quite as generous, but it’s still 5.2%.

I bring up PAC and OMAB because both companies stumbled in 2020 as air traffic ground to a halt. Both also suspended dividends as they kept the cash in house during the worst of the pandemic. This impacted my income in 2020 but the effect was only temporary. Both companies resumed dividends in 2021 and even issued catch-up payouts to help investors make up for the income that was missed in 2020.

The point is this. Diversification is your friend when you’re building a pension portfolio. Companies will panic and cut their dividends during situations like a pandemic or a world financial crisis. By diversifying across multiple names, sectors, and countries, an investor can minimize the impact of these catastrophic events — which, by the way, impact concentrated growth investors far more than conservative income investors.

Besides, income investors can protect themselves from such scenarios by only living off 75% of their income or by keeping a large emergency fund of a year’s worth of spending. Basically, if you’re retired early — like I am — then it pays to build in a few contingencies.

Don’t chase yield

Many beginning income investors make the same mistake, especially when they first start out.

These folks think if dividends are good, then larger dividends are automatically better. After all, who doesn’t want more income?

There’s just one problem. Often these high yields are unsustainable, and payouts get cut. And unlike the Mexican airport stocks, the dividend isn’t reinstated the next year. It’s cut forever.

And, as an insult to the injury, most of the time a dividend cut is accompanied with a swift and painful loss of investment capital as the stock plunges.

I’ve found the best way to avoid dividend cuts is to pay defense. Avoid dividend cut situations by eschewing the riskiest high yield stocks in the first place. Take a very cautious look at stocks that seem to permanently offer a high yield. Analyze their free cash flow, growth prospects, and the stock’s dividend history. And do so cautiously with a high degree of skepticism — it definitely helps in this situation.

One simple trick I think is really effective in this space is limiting your investing universe to the part of each sector that’s a little more conservatively managed than the rest.

For instance, IA Financial (TSX:IAG) is a life insurance company with a higher solvency ratio than its peers, checking in at 142%. That’s well above the company’s operating target of 120%. And it pays out approximately 30% of its earnings towards dividends, compared to a 50% payout ratio for its peers.

If all hell breaks loose in the insurance industry — as it did in 2008-09 — then IA is better positioned to weather the storm versus its peers. And when things are going good — as they do most of the time — then IA’s conservative payout ratio and its solid earnings growth potential should ensure higher than average dividend growth.

All the details of my DIY pension

I share all the dirty details of my portfolio with paid subscribers, including just how much of my money is invested in each stock. I also disclose my buy and sell decisions (mostly buys, I don’t do a lot of selling), and I tell subscribers exactly what I’m thinking as I do it.

I also offer model portfolios, which track either a higher yield portfolio (it targets a 5% yield) or one that offers solid dividend growth (it targets an 8-10% annual dividend increase). These are updated regularly too, as I reinvest the dividends.

The premium version also includes:

• Two long-form pieces of content each week, each Tuesday and Friday

• Dividend safety scores for 110+ Canadian stocks

• My personal watchlist, which is my first stop before deciding which stocks to add to the portfolio

• 200+ articles in the archives, including more than 100 deep dives on individual Canadian dividend stocks

• An ever-expanding library of investing resources, a curated list of tips, tricks, and interesting stuff from the interwebs

• Plus more!

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