Investors for generations have been told to invest for growth. Put money in the market and let it grow. Invest in growth companies. Accumulate investments and then sell them off when you retire. The ongoing mantra we have heard constantly is to:
- Buy Low, Sell High.
- Invest in a broad-market ETF or mutual fund for the long term and your money will be there when you need it later in life.
- Use the 4% Rule – grow your balances to the point where you can withdraw 4% of your balance each year.
This has been the narrative shown to us in the financial press, by our 401k plans, etc.
This is all great in theory – until they fail.
Why can these concepts be pitfalls? Let’s talk about two major risks to this method of investing: market timing and sequence of return risk.
Market timing – I am not talking about getting in and out of stocks at the right time using short term trades. I am talking about the market not returning the annual percentages you are basing your projections on. Historically the U.S. stock market has returned 10.72% on average for the past 30 years. This is a common figure to use when projecting what your balances will be later in life. The problem with using this figure? The market rarely returns the average. There have been multiple stretches of time that the market didn’t return the average, and far from it. Stocks don’t always go up!
2022 so far: -10.37%
One of the people I follow on Twitter, Charlie Bilello, tweeted today the 2022 returns of some of the more popular growth stocks:
2022 Returns…
$TWTR: +13%
$TSLA: -5%
$AAPL: -9%
$AMZN: -13%
$GOOGL: -17%
$MSFT: -18%
$NOW: -27%
$ADBE: -28%
$CRM: -33%
$NVDA: -34%
$SQ: -36%
$TEAM: -36%
$SNAP: -37%
$AMD: -39%
$MRNA: -45%
$FB: -45%
$PINS: -46%
$SNOW: -49%
$PYPL: -54%
$NFLX: -64%
$SHOP: -67%
$RIVN: -68%
If you were looking to use the money invested in these stocks soon you would need to reconsider.
Four months is not that long but there have been entire decades that the market returns were minimal too:
2000-2009: -1% CAGR
1970-1980: 5.9% CAGR
If you were investing during these decades you would come up very short of your goals if you anticipated getting the “average” return. 2000-2009 you actually lost money. An entire decade. A situation like this you may have to delay your plans or reduce the amount of money you planned on using based on these lower returns
Sequence of Returns Risk – You have saved up all your money, invested diligently over the years and have accumulated your desired nest egg. Congratulations! You decide that you have enough to withdraw 4% a year, adjusting for inflation each year in retirement, and set your plan in action. Then the market crashes. Your nest egg you thought you had goes down 30%, or like in 2007-2009 – down 49% during that time. The next year you take out your 4%, the balance in your portfolio is now only a portion of your original amount, so the 4% takes a larger percentage of your original balance.
This is a real risk and can decimate your long term viability of your portfolio.
Schwab has a great article showing the real risk of a downturn during the early years of withdrawal. This graph from the article shows the potential scenarios given two different sequence of returns.
Focusing on a growth only approach can leave your portfolio in trouble when you need it the most!
We can do it differently! How? By focusing on the income portion of your portfolio of course!
Investing in dividend growth stocks, which pay us each year just for being a shareholder, and increase their dividend year after year, allows us to provide the income we need to live off of. By focusing on quality dividend payers, we don’t need to be concerned with the actual returns of the market to live off the proceeds. If we accumulate enough shares to pay us $50,000 in dividends a year (or whatever figure you need), it doesn’t matter if the market goes up, down, or sideways – our quality dividend growth companies will continue to pay – and raise – our income.
The dividend income is based on the companies we buy – their revenue, their growth, their capital allocation decisions – not the whimsical value the market puts on the share prices.
A basket of 30-50 high quality companies can provide us the income we need, and even in a worst case situation of a single dividend cut, we only are down 2-3% of our income, as opposed to a market crash of 30% affecting our portfolio for years. The dividend increases from the rest of our companies will quickly erase that cut too.
Additionally, we don’t run the risk of outliving our money since we are only using the dividend income, not selling down the balance in retirement. This will keep the income coming in and leave a legacy when we are gone.
Investing for growth is not the only way, investing for income can provide a more stable, reliable, and consistent path for future income needs. These quality companies also grow too, so let’s think different!
Great article! I’ve been reading for months on how I need to do my investing. This really does speak to me!
Thanks Jennifer! This is exactly why I became focused on dividends instead of capital appreciation only. After living though the dot com collapse, the financial crisis, and now covid, I can’t rely on the value of the market to be where I need it to be when I need to use the money. Quality dividend growth companies have been there through all of these and keep paying and raising!