A recent report indicates that those nearing retirement think they will need a ~$1.5 million nest egg in order to retire. This makes sense when using tools like the 4% Rule for retirement planning, as this would imply a $60,000 annual ($5,000 monthly) passive income stream from investments that can be added to ~$1,800 monthly for the average retired worker from social security, resulting in a total annual passive income stream of ~$82,000 assuming only one member of the household is eligible for social security. This seems more than sufficient given that in 2022, U.S. households led by someone age 65 or older spent an average of ~$58,000. With inflation, that number is now likely about $60,000. That means that retirees with a nest egg of $1.5 million can live on their estimated passive income alone while the social security checks can serve as a bit of a margin of safety for additional savings, excess inflation, and/or elevated medical expenses down the road.
However, with the S&P 500 (SPY) trading in overvalued territory, leading indicators continuing to show a very high risk of recession, social security on an increasingly shaky financial footing, and geopolitical risks simmering at levels not seen in decades, depending on the 4% Rule seems like an increasingly risky proposition. As Michael Finke, professor and Frank M. Engle Chair of Economic Security at The American College of Financial Services, recently stated:
People often anchor [their savings projection] on the amount they have saved now and will likely answer with a value that they project they’ll have when they retire. Since we’ve essentially had a long-term bull market since 2010, with a couple of blips, this might be coloring people’s estimates.
As a result – especially given that rising interest rates have pushed income-generating sectors like REITs (VNQ), utilities (XLU), and infrastructure (UTF) into the bargain bin, and their dividend yields are currently quite elevated as a result – retiring on the passive income generated by dividends rather than leaning on capital appreciation from a stock portfolio looks more attractive than ever. In this article, we will look at a strategy for living off of dividends from a portfolio of $1.5 million that does not depend on social security at all (by generating $82,000 in dividend income) and is also set up to grow its payouts at a pace that comfortably exceeds the Fed’s long-term 2% inflation target.
Retirement Dividend Portfolio Criteria
To build this portfolio, we need to ensure that each stock first matches each of these four key criteria:
- Defensive and durable business model so that the company can be counted on to pay its dividends through economic expansions and contractions and is unlikely to be disrupted by rapid technological innovation
- Strong balance sheet so that it never has to choose between financial security and paying its dividend
- Well-covered and growing dividend payout so that the company has a margin of safety to keep paying its dividend even if it does fall on temporary hard times and can also continue to grow the payout at a pace that at least matches the long-term rate of inflation in order to preserve our purchasing power.
- High enough current yield to help us to achieve our income goals. In the case of this portfolio, to generate $82,000 in dividend income from a $1.5 million nest egg, we will need to generate an average dividend yield of at least 5.47%.
Additionally, the portfolio needs to be well-diversified, with meaningful exposure to a wide array of industries and individual companies. We will accomplish this by investing in an intelligent mixture of funds and individual stocks. Moreover, while some funds use leverage and/or covered call strategies to enhance their yields, these increase the risk to the passive income stream and can lead to bumpy dividend payouts. As a result, the funds we selected for this portfolio do not use either.
Sample Retirement Dividend Portfolio
Without further ado, here is our sample retirement portfolio, consisting of 3 funds and 10 individual stocks:
Holdings | Amount | % | Yield | Growth |
Enbridge (ENB) | $ 75,000.00 | 5.00% | 8.02% | 4.00% |
Enterprise Products Partners (EPD) | $ 75,000.00 | 5.00% | 7.27% | 4.00% |
Brookfield Asset Management (BAM) | $ 75,000.00 | 5.00% | 3.49% | 15.00% |
Realty Income (O) | $ 75,000.00 | 5.00% | 6.07% | 3.00% |
Mid-America Apartment (MAA) | $ 75,000.00 | 5.00% | 4.75% | 5.00% |
W.P. Carey (WPC) | $ 75,000.00 | 5.00% | 7.16% | 3.00% |
Blackstone Secured Lending (BXSL) | $ 60,000.00 | 4.00% | 10.02% | 0.00% |
Ares Capital (ARCC) | $ 60,000.00 | 4.00% | 9.49% | 0.00% |
Brookfield Renewable (BEP) | $ 75,000.00 | 5.00% | 7.10% | 5.00% |
Brookfield Infrastructure (BIP) | $ 75,000.00 | 5.00% | 6.47% | 7.00% |
Vang. Div. Appreciation ETF (VIG) | $ 285,000.00 | 19.00% | 1.86% | 10.00% |
Schwab U.S. Dividend ETF (SCHD) | $ 270,000.00 | 18.00% | 3.52% | 10.00% |
InfraCap REIT Preferred ETF (PFFR) | $ 225,000.00 | 15.00% | 8.09% | 0.00% |
Total | $ 1,500,000.00 | 100.00% | 5.50% | 6.00% |
As you can see from the above metrics, this portfolio generates more than enough yield to meet our 5.47% yield ($82,000 passive income) threshold and also is set to grow at a weighted average expected 6% per year, which is nearly twice the current rate of inflation and three times the Fed’s long-term target rate of 2%. This sets us up comfortably for preserving our purchasing power over the long term, barring a hyperinflation scenario. It is also worth mentioning that BEP, BIP, WPC, ENB, and EPD all have inflation-linked escalators in many of their contracts/leases, ARCC and BXSL benefit from rising interest rates, and MAA – with their short-term rental leases in its multifamily properties – is also quite inflation resistant, giving the portfolio potentially even greater dividend growth upside in a higher inflation environment.
Additionally, each of our individual stock picks is investment grade and has well-covered dividends along with impressive track records of growing and/or sustaining their payouts through good times and bad. They also each have relatively defensive and durable business models.
Most importantly of all, the portfolio is well-diversified by sector, with VIG, in particular, providing us with exposure to some big technology stocks, while SCHD provides us with exposure to a wide array of dividend growth stocks, PFFR gives us exposure to real estate and fixed income, and our individual stock picks are diversified across REITs, BDCs (BIZD), infrastructure, midstream (AMLP), and utilities.
Investor Takeaway
With inflation remaining elevated, global tensions simmering, broader stock market indexes trading at rich valuations, and the threat of recession remaining elevated, now is a challenging time to be planning for retirement. The good news is that – thanks to the recent steep sell-off in many defensive and durable high-quality dividend stocks – building a passive income dividend stock portfolio is easier than ever. Hopefully, some of the ideas in this article are useful for you towards that end.
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