A couple of days ago, I took some time off from working my worry beads about the Euro fiscal crisis, our own impending fiscal cliff and the upcoming, no doubt, contentious election season.  I figured all the parties to these events could get along without my fretting them along for one day at least.  Instead I just drew a line in the sand at that date and looked back a bit.  I am fully aware that it’s not a good idea to use the rear view mirror to anticipate what’s ahead with respect to investing but, once in a while, looking back can provide a certain perspective. 

State of The Retirement Nest Egg

Actually, the look in the rear view mirror can be pretty ugly when it comes to the investing landscape.  It’s been a rough century so far for those trying to accumulate enough of a nest egg to fund future retirement income.  And it’s been even rougher for those already retired, whose portfolios are dependent upon the market value of their investments to safely withdraw income during retirement.

S&P 500 Since 2000

At the turn of this century, at the end of December, 1999, the S&P 500 index stood at 1469.25; at the end of June, 2012 that index closed at 1362.16.  That’s a 7.3% decline in value over the most recent 12 ½ years.  And the average investor probably spent about another 1% a year in mutual fund and/or advisor fees to achieve something close to that dismal negative result. 

Twelve plus years is almost half of the total average retirement period for people.  It’s a long time to go without any growth in the value of our investments.

There is one area of investing that is absolutely booming, however, and that facet should be of importance to both retired and soon-to-be-retired investors.  Dividends.  Boring, old, periodic cash payouts from companies with profits and with managements committed to sharing those profits with all the owners.

Dividends on the S&P

For the 12 years ending December, 2011, dividends on that S&P index, actual cash money paid out by the companies in the index, increased about 56%.  And so far this year, dividends by these same companies have increased another 14% over last year.  Dividends are on track for an all-time record high year.

Just think about it for a minute.  We’ve got a situation where the earnings of the companies have greatly increased over a fairly long period of time and the dividends from these same companies have also correspondingly increased greatly (and actually so has the ratio of dividends paid out to market value) . . . . . BUT the market’s evaluation of your investments has actually decreased.

Now, I ask you, what should we be focused on?

In the S&P 500, there are currently 399 companies that pay a dividend, even though some of those dividends aren’t all that impressive.  So far this year, only six months,

• 200 of those companies have raised their dividend an average of 14.5%
• 9 companies have initiated a dividend
• Only three – 3! – have decreased their dividend
• Only one – 1! – has eliminated its dividend.

That’s a pretty significant track record.  Those who study market moves say that, over the long run, the market goes up about two-thirds of the time.  It doesn’t seem that way to me over the last dozen years but, even if we accept that thesis, the record of dividend payments is a lot steadier and the direction is almost always up.  This last half-year is more typical than not.

Many studies have been done on the so-called ‘safe withdrawal rate’ – that’s supposed to be the annual percentage you can withdraw from your retirement nest egg starting on the day you retire such that your money lasts longer than you do.  There is some consensus that a withdrawal of 4% of the value of your portfolio in your first retirement year, with that dollar amount increased by 3% each year thereafter for inflation, has a very high probability of lasting 30 years.

Could be.  Maybe.  It depends.

Income Withdrawal During Retirement: Example Comparison

Consider two different retirement situations where a 4% withdrawal of the starting nest egg is desired and where the market declines 10% in year 1 for both and then increases 10% in year 2 for both.

Case #1: Relying On Equity Growth 

Joe has his nest egg invested in equities that pay no dividends.  At the end of year 1, his nest egg has declined 10% and he then takes out the $8,000 he needs for income (4% of $200,000).  He’s now down to $172,000.  But the next year, his stocks go up 10% (to $189,200) and then he withdraws his $8,000.  At the end of two years, his nest egg stands at $181,200.

Case #2: Dividend Pay-Outs As Income

Jill has her retirement nest egg invested in equities that pay her a 4% dividend yield.  At the end of year 1, her nest egg has declined the same 10% as Joe’s, but the $8,000 she withdraws has been paid to her in dividends throughout the year.  She’s now down to $180,000.  But the next year, her stocks go up 10%, the same as Joe’s, to $198,000.  And because the $8,000 of income she withdraws during her retirement was paid to her in dividends, her nest egg at the end of two years is $198,000.

Big difference.  Joe isn’t in nearly as good shape as Jill.

There are those that will say ‘that’s not a valid case study you’ve looked at, you need to assume that the total return of the two different portfolios has the same total return – that is, the percentage total of the increase/decrease in market value plus dividends needs to be equal.’

Don’t you believe it.

Check the numbers.  Check the recent history.  Check your rear view mirror and see where the real growth has been.

Recently, some folks I hadn’t been in touch with for a while reached out to me and said they’d been hearing rumors about an impending fiscal cliff and they wanted to know what was up with that.  I assured them that I hadn’t been all that ‘fisical since I stopped playing ball after high school but I was exercising moderately and I appreciated their concern over my well-being.

When I realized they were after my opinion on the messy business that awaits us all at year-end, I probably wasn’t much more help.

Economic Worst Case Scenario

Without diving into the politics of the situation, it’s been estimated that the combined effect of the payroll tax increase and other tax increases and the mandated sequestration of defense spending at year end will knock our economy for a 4% loop.  We don’t need to have a PhD in economics to know that a 4% haircut to an economy sputtering along now at a 2% growth rate and 8%+ unemployment is not going to be pretty.

If it happens.  Which it won’t.

More Likely Scenario

Sooner or later, the folks we elected will do something.  Chances are it will be later, like after the election and quite possibly after the newly-elected Congress is in place.  It wouldn’t surprise me a bit if the situation doesn’t get dealt with until February, 2013 and the politicos make some or all of their ‘something’ retroactive to January 1.

Now, I said they’d do something.  I didn’t say they’d have a long-term, visionary solution.  The ‘something’ they do might well be just another can-kick.

Between now and whenever our paid government servants actually do something about this problem, my guess is that the market is going to be paying an increasing amount of attention to the abyss that’s just beyond that cliff.  And when the market does begin to anticipate that legislative action might not occur in a timely manner or the something that is done might be not great for the economy, the direction of the market will not be favorable to our existing holdings.

What Could That Mean?

A correction in total market value of 10-15% from present levels could very well happen between now and January of next year.  That’s not a prediction.  I simply don’t know what will happen with the overall market.

Preparing For A Change In Market Direction

But, I do know this.  There’s not an investment I have that I would not buy more of at a 10-15% lower price than it sits at today.  If I had any investment that I would not buy more of at 85-90% of its present market price, I’d sell it tomorrow.  And I’d keep the cash from that sale as dry powder – to buy a more attractive, lower-priced investment if/when this fiscal cliff thing starts to scare the market.