Dividend income doesn’t last forever

Income investors love dividend stocks and for good reason. But dividend stocks aren’t immune from downturns and conservative retirees should think twice before spending all of their dividend income.

Problem is, some companies reduce–or even eliminate–their dividends during hard times, which can be problematic for investors who rely on them. In addition, there have been long periods in the past when inflation cut the purchasing power of dividends.

You can examine past dividend downturns in the accompanying graph. It shows periods when the S&P 500’s dividend fell from its prior peak in inflation-adjusted terms.

For instance, the real (or inflation-adjusted) dividend paid by the S&P 500 fell after the 2008 crash to about 75% of its prior peak. Investors who had been spending all their dividend income before the downturn would have had tighten their belts–or sell a few shares–to get by for a few years.

Dividend investors suffered from a much longer down period during the 1970s and 1980s. The S&P 500’s real dividend peaked in 1966, slipped to about 75% of its former high, and didn’t fully recover until 1990. Those living on their dividends in 1966 would have had to cut back for the next quarter of a century.

In addition, there were some giant downturns in the more distant past when real dividends fell below 60% of their former highs.

As a result, retirees who want to live on their dividends, without selling any shares, would be wise to avoid depending on all of their dividend income. For instance, they might live on 75% of their peak dividend income instead.

Mind you, if you take such a conservative approach, you’ll likely end up leaving a large estate to your heirs. If you want to die broke–or nearly so–then you don’t need to be quite so cautious.

Safer Canadian Dogs

Investors following the Dogs of the Dow strategy want to buy the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), hold them for a year, and then move into the new list of top yielders.

The Dogs of the TSX works the same way but swaps the DJIA for the S&P/TSX 60, which contains 60 of the largest stocks in Canada.

My safer variant of the Dogs of the TSX tracks the 10 stocks in the index with the highest dividend yields provided they also pass a series of safety tests, such as having positive earnings. The idea is to weed out companies that might cut their dividends in the near term. Just be warned, it’s a task that’s easier said than done.

Here’s the updated Safer Dogs of the TSX, representing the top yielders as of July 21. The list is a good starting point for those who want to put some money to work this week. Just keep in mind, the idea is to hold the stocks for at least a year after purchase–barring some calamity.

Notes

Source: Bloomberg, July 21, 2015

Price: Closing price per share

P/B: Price to Book Value Ratio

P/E: Price to Earnings Ratio

Earnings Yield: Earnings divided by Price, expressed as a percentage

Dividend Yield: Expected-Annual-Dividend divided by Price, expressed as a percentage

As always, do your due diligence before buying any stock, including those featured here. Make sure its situation hasn’t changed in some important way, read the latest press releases and regulatory filings and take special care with stocks that trade infrequently. Remember, stocks can be risky. So, be careful out there. (Norm may own shares of some, or all, of the stocks mentioned here.)

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