Saving For Retirement

Those who are still accumulating money for retirement are in an excellent position. Those who are already in retirement can do much better than conventional studies claim. Both should use the techniques developed at this site.

Preserving Capital

The most important investment decision for today is to preserve capital. Valuations are exceedingly high. The upside is limited. The downside is a factor of four.

It is not clear when the market will hit bottom. It could take a decade, possibly fifteen years.

Fortunately, you do not have to spot the bottom. It is sufficient to recognize when the stock market is fairly priced. You can see that by looking at P/E10 or the S&P500 dividend yield or even Tobin’s q. You can buy long before stocks fall to bargain levels. You need to insist on reasonable prices.

Rest assured, however, that there will come a time when you need to buy stocks.

A Simple Rule of Thumb

Here is a simple rule of thumb: wait for dividends to become attractive. Avoid any strategy that requires you to sell shares.

The dividend yield of today’s S&P500 is under 2%. In normal times, it is at least 4%. At bargain prices, it can be close to 8%.

The dividend yield of quality companies that pay high dividends is about twice that of the S&P500 overall. This requires care, paying attention to the quality of the dividend. Reaching 1.5 times the dividend yield of the S&P500 is easily within reach. Simply select high quality (Blue Chip) companies that pay good dividends.

Those who are approaching retirement in 10 to 15 years should be able to buy solid companies easily with dividend yields of 6% or more.

Today’s retirees should read about my dividend blend strategies. They can easily sustain a withdrawal rate of 5% (plus inflation).

Hints

As a rule, dividends rise to match inflation, although sometimes erratically. Many companies have a history of consistent dividend growth.

A dividend investor needs to pay attention to the quality of dividends. To avoid dividend cuts, look at the previous five to ten years of earnings. Focus on how well dividends are covered by smoothed earnings.

How Much to Save

How much you need in retirement depends on your EXPENSES, not your income while working. Frequently, retirement needs are about 30% of working income because (1) the mortgage is paid off, (2) the kids are out on their own, (3) you no longer need to pay into retirement accounts, and (4) you no longer need to pay social security taxes.

With the techniques developed at this site, those who are still in the accumulation stage can plan on a withdrawal rate of 6% (plus inflation) if they wait for dividend yields to rise. It is best to ease into stocks when dividend yields start to become attractive, buying heavily when yields from quality companies are exceptionally high.

Even today’s retirees can plan on withdrawal rates of 5% (plus inflation) by implementing a dividend blend strategy.

For those looking for maximum safety, consider a TIPS-only strategy. At a 2% coupon rate, a TIPS ladder allows you to withdraw 4% of your original balance (plus inflation) for 35 years. This beats the 4% (plus inflation) for 30 years claimed in more traditional studies. Today’s TIPS are yielding close to 2.5%.

Have fun.

John Walter Russell
August 18, 2007