A little bit of yield goes a long way, folks.
While it’s important to never chase yield for the sake of it, which could lead to taking on excess risk by investing in lower-quality companies and experiencing dividend cuts, I think it’s just as important to always be cognizant of your portfolio’s overall yield and how that impacts your long-term financial plans.
My goal all along was to live off of growing dividend income.
I never wanted to sell stocks to produce income. To me, that’s akin to slaying the golden geese that lay the golden eggs. I’d rather keep those geese fat and happy, which allows them to lay an ever-growing amount of eggs for me.
But balancing that desire to never touch principle with the need to generate enough income to live off of is a delicate act that has to be carefully approached and managed.
Careful Construction
Now, I don’t invest much capital any longer. My FIRE Fund is now in “maintenance mode” after achieving my primary financial goal of financial independence and early retirement.
However, I spent six years constructing the Fund in such a way that it would generate enough passive growing dividend income for me to live off of at a young age. And I wanted to make sure I didn’t sacrifice overall portfolio quality or growth prospects in the process.
Yield and growth are generally inversely correlated. Higher-yielding stocks often feature lower growth properties, while lower-yielding stocks often feature higher growth properties. High perceived growth and quality lend themselves to a high valuation, pushing down yield (because price and yield are also inversely correlated, all else equal).
It’s not an exact science, and sometimes an incredible opportunity will buck this trend, but this is the gist of it for most of the time.
In addition, yield and risk tend to correlate pretty closely. Stocks that present extremely high yields (say, 3x+ market) tend to present significant yield because of significant perceived risk. The perceived risk pushes down valuation, thus causing yield to rise. Conversely, high-quality companies tend to be less risky investments that often offer lower yields.
Keeping all of this in mind, I did my best to diversify the Fund across this matrix. I picked up equity in many different businesses that each offered me something a bit different in terms of yield, growth, quality, and risk.
This is how I achieved the balance I sought.
I would invest in a company like Visa Inc. (V) because I saw both the quality and growth prospects as outstanding. In my view, it was a low-risk investment. But it also offered a low yield as a counterweight against the high-growth properties because the stock was in demand and commanded a premium valuation. In addition, Visa has historically paid out a small portion of its earnings in the form of a dividend, further reducing the potential yield.
On the other end of the spectrum, I own equity in Main Street Capital Corporation (MAIN) because I love the huge yield and monthly dividends it offers, all while still maintaining a certain amount of quality as a business. However, because of the nature of the business model (a BDC), it’s a riskier investment for me (relative to a blue-chip dividend growth stock). And the growth will probably not come anywhere close to a Visa. But the nature of that business model almost ensures a big dividend.
These are stocks that feature very different dynamics. But I don’t see one set of dynamics as necessarily superior to the other. They’re just different. Different business models, different dynamics, different objectives across the board.
Of course, the bulk of the portfolio is invested in what I’ve always felt is the “sweet spot” of dividend growth investing – stocks that offer a 3-4% starting yield, 6-7% growth, high quality, and fairly low risk.
Think blue-chip stocks like McDonald’s Corp. (MCD) and Johnson & Johnson (JNJ).
I’ve loaded up on these stocks, particularly when their valuations seemed appealing.
But even a lot of these “sweet spot” stocks have seen their yields fall due to higher valuations across the board (relative to where things were at, say, 5-6 years ago).
If I were only buying these stocks along the way, my portfolio’s yield would be lower than it is today.
And I’d also be far less diversified because that “sweet spot” doesn’t offer a terribly large variety of stocks. It’s akin to a bullseye on a dart board.
I set up a plan when I first started marching toward FIRE that I thought would get me there ASAP. That plan included a thoughtfulness around yield. This is something I discuss in my latest best-selling book, 5 Steps To Retire In 5 Years.
I wanted a portfolio yield that was significantly higher than the market, which could produce enough dividend income for me to live off of without requiring an unrealistic portfolio size.
But I didn’t want to sacrifice too much growth or take on too much risk, for I had to think about both the Jason of 2020 and the Jason of 2050 (the latter of which will be paying higher prices for everything due to inflation).
When I initially did my back-of-the-envelope math, I figured a yield of somewhere around 3.5% on the portfolio would work best. Back then, that’s where many stocks that made the most sense to me as a new investor were at – the “sweet spot” – which was perfect. So I loaded up.
All the same, though, I have a number of small and large holdings that offer me a higher yield along with, in my view, an acceptable range of other aspects across the aforementioned matrix. And this methodology has had the effect of buoying my overall yield. If I wouldn’t have done this, I wouldn’t have been able to start living my dream life as soon as I did.
Because a little bit of yield goes a long way, I’ve been able to keep the bulk of the Fund in blue-chip stocks while still maintaining an overall portfolio yield that fulfills my lifestyle and income objectives. This yield, by the way, is almost twice what the broader market offers, which is a substantial difference.
A Little Bit Of Yield Goes A Long Way
I’m very happy with the Fund. It’s a fine collection of businesses, and I’m very proud of what I’ve been able to build on modest means. I honestly wouldn’t have done things any differently.
That said, I think it’s important to recognize how your overall portfolio’s yield can and will impact your long-term financial plans.
A little bit of yield goes a long way.
To illustrate this, I’ll show you what my own FIRE Fund would look like with a yield that’s 100 basis points lower than where it’s currently at.
Then I’ll compare that to what the Fund would look like if the yield across the portfolio were 100 basis points higher than where it’s currently at.
This is, of course, purely hypothetical. Changing the yield dynamics would change the other aforementioned aspects, too. Yield doesn’t exist in a vacuum. But I do think this exercise is useful for illustrative purposes as it relates to how you go about investing on your way to FIRE.
Not Enough
The FIRE Fund, as of the last monthly update, is worth $398,730.25. It’s expected to produce $13,753.25 in dividends over the next 12 months. That implies a yield of 3.45%. Right in line with the goal I noted earlier.
Including other passive income like royalties from my best-selling books, my total passive income is coming in at over $1,400 per month.
Let’s now assume that yield drops to 2.45% across the portfolio.
The Fund would then generate $9,768.89 in dividend income over the next 12 months. That’s only $814.07 per month.
Guess what?
That’s simply not enough for me, even after factoring in royalties. Not based on my current lifestyle.
I spend between $1,200 on $1,300 per month here in Chiang Mai, Thailand. To be fair, that includes certain luxuries and covering my significant other whenever we’re together. I’m spending something closer to $1,000/month on just my essential expenses, so my dividend income alone does cover me.
However, ~$815/month doesn’t cut it. And I’m not even including visa expenses in this, which are a necessary component to living here. Add another $100/month for that and you can quickly see how the delta is too wide.
Now, I could alter my lifestyle somewhat substantially and get by on that. It’s entirely possible to retire here in Thailand on this kind of income.
I could be single or tell Oh that she has to start covering her own way. I could move into a more basic apartment that has a less central location. Eating at Thai markets for dinner far more often would be a must.
It’d be a situation where I’d be going back to the days when I used to watch every penny.
But I wouldn’t want to do any of that. Not if I don’t have to.
I worked hard to achieve FIRE in order to increase my quality of life and happiness. This isn’t about being miserly. Not for me, at least. I want to live my dream life. It just so happens that my dream doesn’t cost much in Thailand due to person I am, the lifestyle I desire, and the cost structure in place over here.
More Than Enough
Let’s now compare this example to a hypothetical Fund that offers a much higher yield.
I’ll assume the yield rises to 4.45% across the portfolio.
The Fund would then generate $17,743.50 in dividend income over the next 12 months. That’s an impressive $1,478.62 per month.
Almost $1,500 per month would be more than enough passive income for me, especially after factoring in royalties. It would actually be superfluous based on my needs and lifestyle.
However, I’ve never heard anyone complain about having too much money. You won’t hear me complaining, either. I would just see it as additional cash flow for areas that fall outside the normal scope of my daily lifestyle: investing, philanthropy, travel, etc.
But – and this is a big but – that excess current income would come with the disadvantages I laid out earlier.
Namely, I’d most likely be taking on extra risk. And I’d probably be sacrificing some growth in the dividend income, which might limit the opportunities for the Jason of 2040 or 2050. I do try to be just as mindful of that guy as the guy that walks around today. After all, they’re both me.
I would strongly recommend you be mindful of this, too.
Not just thinking of the you of this year or next year as an investor is just as important as not falling into the instant gratification trap as a consumer. Tomorrow will come. And you’ll likely be here to see it. Be careful. Don’t sell that future version of yourself short in pursuit of something unnecessary today.
The “Right” Yield
Is there a “right” yield for a portfolio?
Of course not.
It’s ultimately up to you to construct your early retirement dividend growth stock portfolio in a way that makes the most sense for you.
You have to consider your objectives, risk tolerance, circle of competence, needs, age, time horizon, lifestyle preference, etc.
I will say this: the older one is when starting, the higher the yield they’ll probably need in order to make the numbers work under a reasonable time frame.
Conclusion
The difference between 2.5% and 3.5% on a single stock might not seem like a big difference. Likewise, 4.5% might not seem like a world away from 3.5%.
But it can add up. Quickly.
As you’re buying stocks and constructing your portfolio, be cognizant of how each new stock impacts your overall portfolio yield and your long-term income objectives. The occasional 5% or 6% yielder, assuming the right amount of growth, risk, and quality, can totally change your FIRE trajectory.
Using my own FIRE Fund as a real-life example, we can see how the income swings from ~$815/month to almost $1,500/month when altering the portfolio-wide yield by just 100 basis points up and down. That’s a material change in monthly income (almost doubling from low to high) that has a massive difference in day-to-day lifestyle, opportunities, flexibility, freedom, and attitude.
This scales up, of course, which is something you’d experience as time marches on and your own portfolio grows.
A $1 million portfolio generates $45,000 in annual dividend income at a 4.5% yield, but that annual dividend income drops to $25,000 at a 2.5% yield on the same $1 million portfolio. This could be the difference between being financially independent and not being financially independent.
So make sure you’re aware of the interplay between yield, growth, quality, and risk as you build out your own portfolio. And make sure you’re aware that a little bit of yield goes a long way.
Full disclosure: I’m long all aforementioned stocks.
What do you think? Did these numbers surprise you? How have you constructed your own portfolio? What is your portfolio’s overall yield?
Thanks for reading.
Image courtesy of: Sira Anamwong at FreeDigitalPhotos.net
P.S. If you’re ready to achieve FIRE, check out some awesome tools and services I personally used on my way to becoming financially free at 33!
My current portfolio has a yield of 4.02%. I am trying to keep it at that 4% level so that I hit FI in the next 2-3 years and meet you in Thailand lol. Once I hit FI I will still be able to save $500 – $1000 a month. That extra saving will go toward companies that pay out 2%-3.5% dividend yield but have high growth. That way me of 2040 can still live the FI life. Thanks for putting this in perspective.
FV,
Hey, definitely look me up if you make it out here. 🙂
Sounds like you’ve got a plan. A ~4% yield across the portfolio is a great balance, in my view. You basically are right at that 4% SWR mark without the having to sell assets to generate that level of income.
Best regards.
It’s a fine balance. The steady growth in dividend raises continuously increases the Yield on Cost, for example the yield on the value of my portfolio is at 3.6% but the yield on my cost basis of purchasing is 4.2%. While the former number is unlikely to increase too much but will will likely fluctuate with the market the latter will be rising with the passage of time.
The difference in the numbers is due to the unrealized gains in the portfolio.
Stay well out there up in CM, I hope the air quality is better now.
-Mike
Mike,
Right. It’s a delicate balance. And since there’s no one “right” way to go about it, that balance is going to look different for everyone. I just think it’s important to realize how far a few higher-yielding stocks can go in terms of maintaining the quality and growth you want, but making sure your FIRE/income objectives are also being reached (which will also vary from person to person).
Cheers!
Thanks for the article, adding some higher yielders sure does make a big difference. I’ve been adding some PM and MO over the last year.
Peter,
Definitely. I think, too often, people make it this binary thing between growth and yield. But it’s a spectrum. You can have both, particularly in the context of building out a diversified portfolio that takes advantage of numerous different business models that offer competing/complementing dynamics. I like owning Visa. I like owning those blue-chip “sweet spot” stocks. But I also like owning something like a W.P. Carey, which allows stocks like a Visa to make sense for me while still reaching my income objectives. It’s not mutually exclusive. 🙂
Thanks for dropping by!
Best wishes.
I am wondering if you have ever considered adding a few covered call etf’s to your portfolio to boost yield fairly safely? I have 24 blue chip equities from Canada & the USA, and 4 covered call etf’s on financials, utilities that boost the yield to around the 7% mark, with that bit of a safety net in case the markets drop, knowing that people will not want to sell and give up that yield.
Brian,
No. Not personally interested in that idea, but best of luck with it!
Cheers.
Thanks Jason … one of your best and most interesting and informative posts …James
James,
Thanks. Appreciate that. I felt like this was a very Dividend Mantra type of post. Writing it took me back to 2014… in a good way. 🙂
Best regards!
This is a great post, and it’s something to think about. I’ve built my own portfolio to favor a bit more growth. I’ve kinda had in mind a portfolio that would give me about the market level of yield with significantly higher growth prospects, and I’ve built a portfolio that currently has a bit over a 2% yield, and I’m pretty confident can achieve high single to low double digits growth over the long term, but I’ve been thinking about that yield and the tradeoff. It’ll potentially take me several years longer to reach the initial FIRE point with a yield that low, so I’m thinking about adding in some higher yielding opportunities in order to provide more income. It’s all a balancing act like you said, and I’m still trying to figure out where I’ll end up on that spectrum, but in the current environment (2ish% yields) at least a 2.5-3% yield sounds pretty attractive to me right now, and I think I’ll probably be moving my overall portfolio closer to something like that over the next few months but we’ll see. 🙂
Austin,
Thanks. Glad it provided value and gave you something to think about. That was the intention. 🙂
Yeah, it’s definitely a balance. A unique balance, because it’s really up to each individual to decide what works for them and their objectives. As I grow older and older, I start to favor slightly higher yields because growth becomes less and less important. I mean, if I’m 70, growth matters very little. It’s just the time value of money and figuring out where you need to be.
Best wishes.
Dear Jason,
About what to do with extra money than what you need. It is a constant struggle or dilemna how to invest the dividends (we dont need that income now as our salaries cover our expenses). Moreover luckily we have pension and FREE HEALTHCARE here. But the point of extra cash and ending up taking more risk is interesting.
Cheers,
Rishi
Rishi,
Right. It’s just a question of where you want your investments to fit in that matrix. I personally prefer a nice balance across it all, which is why the bulk of the Fund is in the “sweet spot” – those blue-chip dividend growth stocks. But I also have a number of investments that fall in different areas, as I’ve been cognizant all along of my income objectives. I’m highly interested in taking care of the Jason of 2050. But the Jason of 2019 certainly doesn’t want to need a job because the Fund’s yield isn’t high enough. 😂
Cheers.
Really interesting post. Made me stop and think about my investment mix and what I should be adding next. Thanks for steering me in that direction. I haven’t thought about that in quite a while.
SR,
Glad you found it interesting. I don’t discuss stuff like this too much, especially nowadays. But it’s very important to set those objectives and then make sure the portfolio’s holdings and yield are right-sized. The good news is a little bit of yield goes a long way. So you can quickly correct/improve your trajectory, if you find yourself off course. 🙂
Best regards!
Hi Jason,
this is a question which is very seldom discussed. What I can see is that there are several people outside specialized on high yielders. Especially with REITs you can achieve high results with 6 – 8% and with this you are able to reach good payout amounts in a fairly short time. If I look for example at ARI or STWD, you get stable payments from 8,5% to 10% the last years. The main disadvantage is, that the dividend is the same over the years, so you lose the inflation every year. On the other side you can get with 120.000 $ around 10.000 $/dividends per year which should be enough for a living in Thailand. You now have the big but: You will get every year a lower amount of money, if you spend everything for your living. On the other side if you spend 2/3 of the money and reinvest the rest you will do good as long as the companies are healthy. But you must be active every year and because of the higher risk of the two REITs this can change in a short time, if one of them fails. A good example is SNH, which is very volatile the last 2 years and they are doing not well, if you look how successful they handle their business modell.
From my side I have some high yielders like the two above, also MAIN and others. On the other hand I also have a lot of grow stocks which don´t pay much and a few which pay nothing like Facebook and Alphabet. These are not 100% in my strategy because I´m living from my dividends, but the growth is high and I´m in the situation now that I don´t need every dividend. When I look in my portfolio I have many average growth stocks and they are the most successful if I combine the worth of the stock and the dividends. These average growth stocks also increase the dividends with a high percentage and they free me from inflation. I have nothing against for example T, EMR or PG, these are great companies with a good payout, stable and a good business modell. But to be honest they are not much better than the REITs above, because the increases are so moderate, that the development is not too good.
I think, a portfolio from growth to high yielders with everything in it is the best solution to not worry about the future. Every sort of share has its own sense and when you are between 3 and 3.5% average dividend yield overall you are in a very good spot. The infrastructure should be average on every aspect: 1/3 high yield, 1/3 companies with average dividends and big companies like in the Dow Jones or other main indexes and 1/3 growth. With that you can´t fail, I think. For me this worked well.
Regards
Oliver
Oliver,
There are a lot of options out there. That’s what’s fun and interesting about investing. So many different ways to approach a similar objective. Many different means to the same end.
For me, I’ve found a wonderful balance. This has allowed me to retire in my early 30s, live off of passive income, easily grow passive income in excess of inflation, and also know that the underlying assets will grow at appealing rates over the long haul (which is, in the end, more philanthropic firepower down the road). All in all, I’m nothing short of incredibly pleased and fortunate. 🙂
But I do think it’s important to be cognizant of where your portfolio’s overall yield is at, and whether or not that’s going to get you to where you want/need to be. Fortunately, it’s not difficult to increase/improve yield without totally sacrificing quality or taking on too much risk. That’s especially true when you build out a broadly diversified portfolio that is, at its core, a well-oiled machine that’s chock-full of some of the best businesses in the world. I love owning slices of V, SCI, HRS, etc. Just as well, the likes of WPC, MAIN, and GEO juice things just enough to keep my lifestyle possible, flexible, and, frankly, amazing. It’s very possible to balance oneself across that matrix and still achieve FIRE in a very short period of time.
Thanks for adding that!
Best wishes.
Very important topic ! Time is important when looking at your portfolio income. Dont dwell to much on value. I have been at this for a long time and rode out my fair share of market corrections. Looking back I always wished I had invested more when the market is low.
My current yeild is at %5.524 and I only take %80 of my dividend and reinvest the rest so its always growing. For years I adusted my ratio just once a year but Im thinking I may change that to twice a year.
Its exciting when your portfolio is paying more than you need the ” Snowball ” really geats big at that point. It does take many years to get there but then again its in the future ( due to inflation ) when you will need the extra money.
Best investing wishes to all 🙂
Bob
Bob,
Wow. That’s a super high yield across your portfolio. I just wasn’t able to get to something like that without sacrificing something else (quality, growth, diversification, etc.) that was important to me when thinking about sustainable and growing income for five decades or so. But it sounds like it’s more than enough for you, which allows you some reinvestment opportunities. That’s great.
Thanks for dropping by!
Cheers.
Jason, are you familiar with the “Choose FI” podcast? They did an episode that I’d call a hit piece on dividend investing as opposed to index investing to arrive at FI. You should reach out to them and set them straight. They seem to equate dividend investing with reckless stock picking. This is what happens when the conventional wisdom of index investing calcifies into a form of dogma that views other approaches to investing as heresy.
Joe,
This isn’t related to the topic above.
I don’t actually listen to any podcasts, but I’m familiar with Choose FI only because they invited me on the show. However, we couldn’t make it work because they wanted me to purchase a nice microphone to improve sound clarity. I thought it was hypocritical to spend good money on a mic that I’ll use once and throw away, just to then go on and talk about being mindful with consumption and spending. They disagreed. So we never did the episode.
That said, if someone wants to follow or perpetuate dogma, that’s up to them. I’m not interested in arguing or debating, nor do I find myself caring about what other people think. I see my mission as purely inspirational and motivational. Moreover, it doesn’t behoove me to convince anyone to buy my stocks. All that does is make them more expensive for me and the companies buying back their own stock, which works against me. I suppose you can look at the dogma optimistically – most Americans are woefully short on quality equity assets, so even a dogmatic approach is better than no approach.
Cheers!
I like the idea of adding higher yield early on in the journey, this was your snowball may not be as safe, but you can build a bigger snowball early on to really get things going. Furthermore, REITS pay monthly, which gives the metaphoric “BB gun” (as Jason calls it) more shots at it early on. My advice for beginners, if you can find a platform with no fees (just ask!) then starting early with REITS and shooting bb’s (re-buying often) is the way to go!
Once you’re well on your way, start diversifying into less, more growth, more blue-chip, and difference sectors! Great post Jason!
Rob,
Yeah, I actually described this approach a number of years ago:
https://www.dividendmantra.com/2014/06/a-multistage-rocket-model-for-a-dividend-growth-stock-portfolio/
If you can get the dividend income pumping at a good rate very quickly, that might allow you to start aggressively rolling that snowball earlier than otherwise. 🙂
Best wishes.