While Berkshire Hathaway itself does not pay a dividend because it prefers to reinvest all of its earnings for growth, Warren Buffett has certainly not been shy about owning shares of dividend-paying stocks. We will analyze each of Buffett’s dividend stocks in this article.

A dividend is often the sign of a financially healthy and stable business that is committed to rewarding shareholders. These are some of the qualities Warren Buffett looks for when he invests.

Berkshire Hathaway Portfolio Update

Warren Buffett’s Investment Strategy

Warren Buffett’s portfolio remains concentrated today, and his three largest positions each account for over 10% of Berkshire Hathaway’s portfolio. The idea behind running a concentrated portfolio is that there are relatively few excellent businesses and investment opportunities in the market at any given time, and owning too many positions reduces the impact from your few best ideas.

Importantly, Warren Buffett’s investment strategy has always been focused on the concept of staying within one’s circle of competence. Buffett has said that “risk comes from not knowing what you’re doing.”

In other words, never invest in a business or industry that is too hard for you to understand. The reality is, most investment opportunities fall outside of our circle of competence and should be ignored. 

Since the days of his initial partnership, Buffett’s strategy has evolved to concentrate more on buying up wonderful businesses at reasonable prices rather than digging through the bargain bin for “cheap” stocks. He looks for companies that have strong economic moats and numerous opportunities for growth.

Analyzing Warren Buffett’s Top High-Yield Dividend Stocks

Percent of Warren Buffett’s Portfolio: 0.2%
Dividend Yield: 8.1%   Forward P/E Ratio: 36.0x   (as of 11/18/19)
Sector: Energy   Industry: Integrated Oil and Gas
Dividend Growth Streak: 16 years

Percent of Warren Buffett’s Portfolio: 4.2%
Dividend Yield: 5.1%   Forward P/E Ratio: 12.0x   (as of 11/18/19)
Sector: Consumer Staples   Industry: Miscellaneous Food
Dividend Growth Streak: 0 years

“The short term doesn’t make much difference to us, because we will be in this stock forever. This is a business with us. It’s not really a stock…It’s where the new Kraft Heinz Co. is 10, 20, 50 years from now that counts to Berkshire. These are brands I liked 30-plus years ago, and I like them today. And I think I’ll like them 30 years from now.”

“When you’re going toe to toe with a Walmart or a Costco or maybe an Amazon pretty soon…you’ve got the weaker bargaining hand than you did 10 years ago…

Costco introduced the Kirkland brand in 1992, 27 years ago, and that brand did $39 billion last year whereas all the Kraft and Heinz brands did $27, $26 or $27 billion.

So here they are, a hundred years plus, tons of advertising, built into people’s habits and everything else, and now Kirkland, a private label brand, comes along and with only 750 or so outlets does 50% more business than all the Kraft-Heinz brands.

So house brands, private label, is getting stronger. It varies by country around the world, but it’s bigger. And it’s gonna keep getting bigger.” 

3: General Motors (GM)

General Motors is one of biggest manufacturers of cars and trucks in the world. Most of the company’s sales are pickup trucks and crossovers, which carry higher margins than passenger cars. 

However, the “new” GM is much stronger than its predecessor and has substantially improved its earnings power and financial health, which management hopes will allow the company to continue paying its dividend during the new industry downturn.

Buffett’s favorite holding period is “forever,” and he probably sees plenty of room for General Motors to continue growing its earnings over time as it continues cutting costs and making investments in higher-margin areas.

While the auto industry is certainly cyclical, GM appears well positioned to get through almost any environment and remain relevant for a long time to come.

4: Suncor (SU)

Percent of Warren Buffett’s Portfolio: 0.2%
Dividend Yield: 4.0%   Forward P/E Ratio: 14.6x   (as of 11/18/19)
Sector: Energy   Industry: Integrated Oil & Gas
Dividend Growth Streak: 16 years

SU is an integrated energy company focused on developing Canada’s oil sands. Oil sands is a mixture of bitumen, sand, fine clays, silts, and water. Because it does not flow like conventional crude oil, it must be mined or heated underground before it can be processed.

5: Wells Fargo (WFC)

Overall revenue is split almost equally between traditional loan-making operations and noninterest income from brokerage advisory services, credit card fees, commissions, mortgage originations, and more.

Banking can be a disastrous business to invest in if reckless loans are issued, so the company’s management and culture are extremely important factors. In the case of Wells Fargo, it was historically thought to be one of the highest quality and most conservatively managed banks.

Buffett also probably likes Wells Fargo for the long haul because it possesses major cost advantages over its smaller peers. The bank has more retail deposits than any other bank in America and has seen its total deposits grow from $3.7 billion in 1966 to $1.3 trillion as of the end of 2018.

As the U.S. economy continues expanding, Wells Fargo should be able to mint money with its loan book and continue earnings superior returns on equity relative to its peers.

Specifically, he commented that most of Berkshire’s best investments (American Express, Geico) were in firms that fell into trouble due to poor incentive systems that caused short-term problems. All big banks have had troubles, but he sees no reason why Wells Fargo would be inferior to other banks from investment and moral standpoints going forward.

Buffett and Munger like how the firm is correcting the bank’s mistakes and see no reason why Wells Fargo will be anything other than a large well-run bank that comes out stronger from this. Munger even suggested that Wells Fargo might be the bank that is most likely to behave the best in the future as a result of faulty incentive system coming to light.

6: STORE Capital (STOR)

Percent of Warren Buffett’s Portfolio: 0.3%
Dividend Yield: 3.5%   Forward P/AFFO Ratio: 19.7x   (as of 11/18/19)
Sector: Real Estate   Industry: Retail REIT
Dividend Growth Streak: 5 years

STORE Capital is a real estate investment trust that Berkshire Hathaway acquired an initial stake in during the second quarter of 2017. While the company only accounts for about 0.3% of Buffett’s portfolio, Berkshire owns approximately 8.7% of the firm’s shares.

STORE is a net-lease REIT that primarily owns single tenant, retail-focused properties. Service assets (e.g. early childhood education, health clubs, pet care, movie theaters) account for 65% of its rental income, followed by retail (e.g. furniture stores, home goods, outdoor outfitters, hobby centers) at 18% and manufacturing (e.g. playground equipment, medical devices, aerospace components) at 17%.

STORE Capital has more than 400 customers (top 10 are less than 20% of total rent) and over 2,200 investment property locations across 48 states. STORE’s property investments total more than $6 billion, and management believes the market for its properties exceeds $2.6 trillion in value (more than 1.6 million properties), providing ample room for growth.

7: Phillips 66 (PSX)

Phillips 66 was spun off from ConocoPhillips in 2012 and generates the majority of its profits from refining oil, marketing refined petroleum products such as gasoline, and selling various chemicals such as plastics that are made from oil.

Management is investing in midstream and chemicals operations to drive future growth, which will make the business less dependent on refining and provide more balanced cash flows.

8: United Parcel Service (UPS)

United Parcel Services was founded in 1907 and has grown to become the largest package delivery company in the world. In fact, UPS delivers 20 million packages and documents each day to around 10 million customers located in more than 220 countries and territories.

Warren Buffett has owned United Parcel Services since 2007, although it has remained a very small part of Berkshire Hathaway’s portfolio.

Despite the small position size, UPS has strong competitive advantages. As a logistics company, UPS derives its economic moat from being a world-class operator with extremely efficient business processes. The company has invested heavily to build out its network over the years.

9: Coca-Cola (KO)

Coca-Cola might be Warren Buffett’s most famous stock investment. Buffett scooped up a major stake in Coca-Cola in 1988 after the 1987 stock market crash made the company’s valuation too enticing to pass up.

Coca-Cola’s strong brands and extensive distribution system around the world have enabled it to become the number one provider of sparkling and still beverages and increase its dividend for over 50 straight years, qualifying the company as a member of the dividend kings list.

10: Restaurant Brands (QSR)

Percent of Warren Buffett’s Portfolio: 0.3%
Dividend Yield: 3.0%   Forward P/E Ratio: 23.2x   (as of 11/18/19)
Sector: Consumer Discretionary   Industry: Food & Restaurants
Dividend Growth Streak: 5 years

Restaurant Brands International is the parent company of Burger King and Tim Hortons, which combined in 2014 to claim the title of the world’s third-largest fast food business with over 20,000 restaurants.

Tim Hortons was founded in 1964 and is the largest quick service restaurant chain in Canada. The restaurant specializes in coffee, baked goods (e.g. doughnuts), and home-style lunches.

Berkshire Hathaway also owns $3 billion of preferred shares in the company, which pay him a high-yield dividend of 9% each year. 

The consumer sector is home to many famous brands and has historically been one of Warren Buffett’s favorite places to pick stocks.

Burger King and Tim Hortons are two of the most well-known restaurant brands in the United States and Canada.

Importantly, both businesses seem to have plenty of potential for international growth. Burger King is already in more than 100 different countries, and Tim Hortons has little presence outside of Canada.

The company’s global scale, brand recognition, and prominent locations make it a free cash flow machine that should enjoy steady growth over the long term.

11: PNC Financial Services (PNC)

12: U.S. Bancorp (USB)

Percent of Warren Buffett’s Portfolio: 3.4%
Dividend Yield: 2.8%   Forward P/E Ratio: 13.6x   (as of 11/18/19)
Sector: Financials   Industry: Major Regional Banks
Dividend Growth Streak: 9 years

By business line, U.S. Bancorp generates 32% of its net income from consumer and small business banking, 21% from payment services, 23% from wholesale banking and commercial real estate, 13% from treasury and corporate support, and 11% from wealth management and securities services. 

Overall, fee income accounted for 42% of total revenue in 2018. The company’s diversification makes it a more consistent and predictable business.

U.S. Bancorp has been one of Warren Buffett’s stock picks since before the financial crisis when he initiated a position in early 2007.

The company has a strong history of making high quality loans and remaining well capitalized relative to peers. As a matter of fact, U.S. Bancorp is the highest rated peer bank across all rating agencies when it comes to debt, providing it with funding and competitive advantages.

If Buffett owns the stock, it is safe to assume that USB’s culture is a conservative one that manages risk very carefully. This discipline shows up in USB’s profitability and efficiency metrics, which rank better than its peers.

Bank stocks look relatively cheap today because interest rates are expected to remain lower for longer. When rates are low, banks make less money on their lending operations.

Despite the tough environment for banks, USB’s loan portfolio has been growing at an annualized rate near 7% over the last decade.

The company’s loan book is also well-diversified and maintains little exposure to volatile energy markets (less than 2% of total exposure). U.S. Bancorp also has an A+ credit rating from S&P.

Warren Buffett owns U.S. Bancorp because it is a high quality, conservatively managed business that has demonstrated an ability to achieve consistent growth. Over time, these types of companies should compound shareholders’ capital nicely.

13: JPMorgan Chase (JPM)

• Relationships with 50% of U.S. households
• Does business with over 80% of Fortune 500 companies
• #1 U.S. credit card issuer
• #1 in North America and EMEA in investment banking fees
• More than 5,000 branch locations

The firm’s operations are extensive, spanning consumer and community banking (39% of earnings), corporate and investment banking (44%), commercial banking (14%), and asset and wealth management services (9%).

Thanks to its large size, diversification, and massive base of low-cost deposits ($1.4 trillion, of which about 30% have no interest cost), JPMorgan is a very efficient and profitable bank that is able to make money in practically any environment. Impressively, due to the bank’s status as a low-cost producer, management also targets a return on tangible equity of 17%.

CEO Jamie Dimon runs JPMorgan very conservatively as well. The bank’s capital reserve profile is even more conservative than the levels mandated by the Federal Reserve to help keep banks solvent during a severe global economic downturn, for example.

With bank stocks struggling throughout most of 2018 and early 2019, Berkshire Hathaway saw an opportunity to finally buy into one of the most impressive financial companies on Wall Street.

Read More: Our Analysis of JPMorgan Chase

14: Johnson & Johnson (JNJ)

Percent of Warren Buffett’s Portfolio: 0.02%
Dividend Yield: 2.8%   Forward P/E Ratio: 15.6x   (as of 11/18/19)
Sector: Medical   Industry: Pharma
Dividend Growth Streak: 57 years

Johnson & Johnson is one of the biggest healthcare companies in the world with over $80 billion in sales. Most of J&J’s profits are from sales of branded pharmaceuticals, but the company also has big consumer products and medical devices businesses.

Johnson & Johnson used to be one of Buffett’s biggest holdings 10 years ago but is one of Berkshire Hathaway’s smallest holdings today.

Why did Warren Buffett invest in Johnson & Johnson in the first place? For one thing, healthcare is one of the best stock sectors for dividends because of its stability.

People require healthcare products and services regardless of how the economy is doing, which makes Johnson & Johnson’s cash flows very reliable. The company’s sales were only down in the low-single digits during the financial crisis, and JNJ’s stock beat the S&P 500 by 29% in 2008.

To remain competitive, the company invests over $7 billion in research and development each year. While the development of new drugs is risky, Johnson & Johnson has an excellent track record and can use the predictable cash flows from its consumer businesses to steadily fund new product research.

15: Delta Air Lines (DAL)

Delta Air Lines is one of the biggest passenger airlines in the world. The company has routes servicing over 340 destinations located across more than 60 countries. Delta Air merged with Northwest Airlines in 2008 to create the largest airline in the world.

Volatile fuel prices, costly union labor forces, steep price competition, and capital intensive operations are just some of the major challenges faced by airlines. There are some positives, however.

The high costs required to operate an airline create barriers to entry. A large operator such as Delta can spread its fixed costs across all of its routes, allowing it to deliver it services more efficiently than smaller rivals or new entrants. Only so many routes between two destinations are needed as well, making it all the more difficult for a new player to gain share.

According to the Wall Street Journal, American, United Continental, Delta Air Lines, and Southwest now control more than 80% of U.S. domestic capacity, up significantly from five years ago prior to the merger consolidation activity.

It remains to be seen if this consolidation can result in a more rational competitive environment, marked by higher ticket prices and improved profitability from economies of scale and restructuring initiatives.

These qualities help Delta generate great free cash flow and earn a higher return on capital, which creates potential for faster earnings growth. Given the size of Warren Buffett’s portfolio, the firm needs to invest in rather capital intensive businesses that are big enough investment targets. Airlines apparently fit the bill, but they remain in the “too hard” bucket for me.

16: Bank of New York Mellon (BK)

Percent of Warren Buffett’s Portfolio: 1.7%
Dividend Yield: 2.6%   Forward P/E Ratio: 11.9x   (as of 11/18/19)
Sector: Financials   Industry: Major Regional Banks
Dividend Growth Streak: 9 years

The company’s investment management business offers a range of investment strategies (e.g. equities, fixed income, alternatives), investment vehicles (e.g. mutual funds, separate accounts), and wealth management services (e.g. estate planning, private banking).

BNY Mellon’s investment services include execution and processing of trades, servicing investments (e.g. outsource middle office functions, safekeep assets), and capital and liquidity services (e.g. optimize funding and operating capital, access global markets).

Warren Buffett’s Berkshire Hathaway bought its first shares of Bank of New York Mellon during the third quarter of 2010 and boosted his stake significantly in 2017 and 2018.

One of the reasons why Warren Buffett might have been attracted to BNY Mellon is because the company is solely focused on the investment process and the investment life cycle. As a result, the firm has amassed strong market share positions across most of its businesses.

This has helped BNY Mellon build up sizable scale in its markets, enabling it to provide the most cost-effective and comprehensive services to its clients.

The company seems very likely to remain a pillar of the world’s investment infrastructure and will continue being relevant and highly profitable for many years to come. The business also stands to benefit if interest rates normalize.

17: M&T Bank (MTB)

The company acquired Hudson City Bancorp in late 2015 for $5.2 billion, increasing its loan portfolio by nearly 30% while providing meaningful opportunities for cost savings and growth in adjacent markets.

The deal further improves M&T regulatory capital ratios, was immediately accretive to book value per share, and offers an attractive internal rate of return of about 18%.

M&T has been one of Berkshire Hathaway’s stock picks since Buffett bought preferred stock in the company back in 1991. His shares later converted into common stock about five years later.

As a result, M&T has consistently outperformed its peers as measured by profitability, efficiency, and net charge-off ratios. The company has also grown its net operating earnings per share by 15% per year since 1983 and avoided posting a loss each year since 1976, steadily compounding its value along the way.

Shareholders have also been rewarded over this time period, enjoying 13% annualized dividend growth since 1983 and an annual total return north of 17% since 1980 – that’s among the 30 best returns of all U.S.-based stocks that traded publicly since 1980.

18: Procter & Gamble (PG)

Percent of Warren Buffett’s Portfolio: 0.02%
Dividend Yield: 2.4%   Forward P/E Ratio: 24.3x   (as of 11/18/19)
Sector: Consumer Staples   Industry: Soap & Cleaning Preparations
Dividend Growth Streak: 62 years

Buffett had gradually been reducing his stake in P&G over the last decade and announced an agreement in late 2014 to buy Duracell from P&G in exchange for his shares of P&G.

The deal closed in 2016, so Buffett’s remaining P&G stake is extremely small. However, Berkshire Hathaway likely wanted to own Duracell because of its strong brand recognition and market share (25%). It’s also worth noting that Duracell was part of P&G’s acquisition of Gillette, so Buffett had plenty of familiarity with the company already.

19: Synchrony Financial (SYF)

Percent of Warren Buffett’s Portfolio: 0.3%
Dividend Yield: 2.4%   Forward P/E Ratio: 8.3x   (as of 11/18/19)
Sector: Financials   Industry: Consumer Loans
Dividend Growth Streak: 3 years

Warren Buffett is no stranger to Synchrony Financial’s business (credit cards), which was the consumer finance unit spun out from General Electric in 2015. Berkshire had a stake in GE since the financial crisis, and the firm owns a stake worth more than $10 billion in American Express (AXP) and smaller positions in Visa (V) and Mastercard (MA).

Synchrony’s card volume should presumably rise over time as its partners continue expanding their businesses and more shopping takes place online, which requires greater use of credit cards rather than cash.

SYF’s stock sold cratered nearly 20% in late April 2017 after reporting weak earnings. The company’s revenue grew 14% year-over-year, but investors worried after seeing that Synchrony increased its provision for loan losses by 45%, reducing the earnings outlook for 2017 and bringing into question the quality of the firm’s loan book.

Berkshire saw an opportunity to pounce on the stock and took it. Buffett seems to believe that Synchrony has a number of long-term growth opportunities and that its spread business remains in good shape, even after accounting for the higher charge-off rate.

20: Travelers Companies (TRV)

Percent of Warren Buffett’s Portfolio: 0.4%
Dividend Yield: 2.4%   Forward P/E Ratio: 12.8x   (as of 11/18/19)
Sector: Financials   Industry: Property and Casualty Insurance
Dividend Growth Streak: 14 years

Warren Buffett’s history with Goldman Sachs dates back to the financial crisis. Berkshire Hathaway purchased $5 billion shares of preferred stock that paid a high-yield dividend of 10%.

Warren Buffett also received warrants that were later converted into roughly $2 billion of Goldman Sachs’ shares.

The company remains the number one ranked merger advisor and equity underwriting franchise and does investing banking business with over 8,000 clients across 100 countries. The firm clearly dominates the M&A market.

While banks are still contending with a challenging regulatory and macro environment today, Goldman will remain a key player in finance for decades to come.

22: Bank of America (BAC)

Percent of Warren Buffett’s Portfolio: 12.4%
Dividend Yield: 2.2%   Forward P/E Ratio: 11.2x   (as of 11/18/19)
Sector: Financials   Industry: Diversified Banks
Dividend Growth Streak: 6 years

Warren Buffett became involved with Bank of America back in 2011 when he purchased $5 billion of preferred stock yielding 6% and received warrants for 700 million shares that Berkshire could exercise over the next 10 years.

“As recently as 2014, Bank of America’s results were dogged by tens of billions of dollars in penalties over financial-crisis era issues. Since then, the company’s legal problems have eased and it has made a concerted effort to cut costs and focus on safer businesses like lending to consumers with good credit.”

Buffett is no stranger to banks and owns a number of financial services firms in Berkshire’s portfolio. As long as they manage risk well and are conservatively run, banks mint money. Bank of America made one bad decision after another leading up to the financial crisis, but Buffett is clearly a believer in its new leadership and their ongoing turnaround plans for the company.

23: Mondelez International (MDLZ)

Percent of Warren Buffett’s Portfolio: 0.01%
Dividend Yield: 2.1%   Forward P/E Ratio: 20.8x   (as of 11/18/19)
Sector: Consumer Staples   Industry: Miscellaneous Food
Dividend Growth Streak: 6 years

Kraft Foods spun off Mondelez in October 2012. Mondelez is a giant food company focused primarily on snack products (85% of sales). The company owns iconic brands such as Oreos, Ritz, Chips Ahoy, Cadbury, and Trident.

Berkshire Hathaway’s small position in Mondelez dates back to late 2012 when Kraft Foods completed its spin-off of the company through a stock distribution.

Warren Buffett was an existing Kraft Foods shareholder and therefore received shares of Mondelez.

Given Berkshire Hathaway’s stake in Kraft Heinz, we know that Buffett likes this type of business. It’s simple to understand, sells essential products, owns a portfolio of strong brands, generates highly predictable cash flows, and can cut costs to drive margins higher.

The global snacking market also offers plenty of room for growth. The company estimates its size at more than $1 trillion and expects growth to be driven by rising consumption in emerging markets.

With number one global market share positions in biscuits, candy, and chocolate, Mondelez should benefit over time as consumption grows.

While Mondelez is far from an exciting business, Warren Buffett’s “slow and steady” investment strategy has been a good one.

24: American Express (AXP)

American Express is one of Warren Buffett’s oldest and most successful stock picks. Buffett first invested in American Express in the mid-1960s, and the company remains one of his largest positions today.

While the competitive environment has intensified and new cardholder growth has become more challenging to come by, Warren Buffett’s massive unrealized gains on his shares of American Express will likely keep him in the stock for a long time to come (his tax bill will be enormous once he sells).

25: Southwest Airlines (LUV)

Percent of Warren Buffett’s Portfolio: 1.4%
Dividend Yield: 1.3%   Forward P/E Ratio: 12.3x   (as of 11/18/19)
Sector: Transportation   Industry: Airlines
Dividend Growth Streak: 8 years

As a result, full-service airlines can never compete with Southwest on cost, and the airline has been better able to survive the industry’s unpredictable ups and downs compared to its rivals.

Berkshire Hathaway began buying shares of Southwest during the fourth quarter of 2016, adding a fourth airline holding to its portfolio.

Given the amount of consolidation that has taken place in the airline industry over the last decade (the four largest carriers control over 80% of U.S. domestic capacity), Buffett likely believes “this time is different.”

With more power resting in fewer hands, the airline industry could finally become a more rational and profitable market for the long term. Many investors are biased against the industry given its checkered history, potentially setting up a great investment opportunity. Buffett’s smattering of bets on four different airlines seems to indicate he is bullish on the entire space rather than a single operator.

Remember the last part of Warren Buffett’s quote that we reference above:

“If [the airline industry] ever gets down to one airline it will be a wonderful business…”

26: American Airlines (AAL)

The high costs required to operate an airline create barriers to entry. A large operator such as American Airlines can spread its fixed costs across all of its routes, allowing it to deliver it services more efficiently than smaller rivals or new entrants. Only so many routes between two destinations are needed, too, making it all the more difficult for a new player to gain share.

It remains to be seen if this consolidation can result in a more rational competitive environment, marked by higher ticket prices and improved profitability from economies of scale and restructuring initiatives.

Percent of Warren Buffett’s Portfolio: 25.9%
Dividend Yield: 1.2%   Forward P/E Ratio: 20.2x   (as of 11/18/19)
Sector: Technology   Industry: Mini Computers
Dividend Growth Streak: 7 years

Apple sells smartphones, tablets, computers, and an assortment of software, services, and accessories. iPhones have been the biggest driver of Apple’s growth and accounted for approximately 63% of the company’s total revenue last fiscal year. Apple computers (Macs) accounted for 10% of sales, and iPads made up another 7%. Software, services, and sales of other hardware such as iPods accounted for the remaining 21% of Apple’s revenue.

Apple is also a free cash flow machine. Over the last decade, Apple’s free cash flow grew from 25 cents per share in fiscal year 2005 to $12.80 in fiscal year 2019. Throughout that period, Apple’s annual return on equity averaged an outstanding 30%.

Of course, history doesn’t repeat itself – especially in the tech sector. Much of Apple’s success was fueled by the mass adoption of smartphones. That market is now saturated, which has caused Apple’s growth to cool off and had sent its stock down nearly 30% before Berkshire stepped in.

As a result, Buffett was able to buy in to the world’s most valuable brand for less than 11 times earnings. Buffett likely didn’t buy Apple for its smartphone franchise but rather for its future growth opportunities. As usual, he is looking out a number of years while the market is focusing on Apple’s next few quarters, which will likely remain challenged due to smartphone saturation.

From self-driving cars to virtual reality, an expanding array of high-margin services, and a slew of other smart devices and software applications yet to be invented, there are numerous paths Apple can pursue for growth.

Buffett generally prefers to invest in more predictable businesses that don’t have to reinvent themselves, which makes his bet on Apple a bit surprising.

28: Costco (COST)

Percent of Warren Buffett’s Portfolio: 0.6%
Dividend Yield: 0.9%   Forward P/E Ratio: 35.4x   (as of 11/18/19)
Sector: Consumer Discretionary   Industry: Discount Retail
Dividend Growth Streak: 15 years

Costco started in 1983 and is the largest wholesale-club retailer in the country. The company operates large membership warehouses that offer members reasonably low prices on an assortment of products covering categories such as groceries, electronics, apparel, and more.

Costco has been one of Warren Buffett’s stock picks since 2000. Berkshire Hathaway scooped up shares after the stock plunged by nearly 40% during the year.

Buffett was very familiar with the company as Berkshire’s vice chairman, Charlie Munger, served on Costco’s board in the late 1990s.

Costco’s advantages begin with its 80 million cardholders (a membership card is required to shop at Costco). The company’s large group of customers provides Costco with excellent purchasing power over its suppliers, helping keep prices below traditional wholesale or retail outlets.

Management also keeps the company focused on providing excellent value by eliminating as many frills and costs as possible. Costco stores are far from extravagant on the inside and even eliminate the use of bags at checkout to save money and price their products lower.

As a result of its low prices, quality merchandise, and simple shopping experience, Costco’s membership renewal rate has been excellent at around 90%.

What’s held Buffett back from buying more of this wonderful business? Unlike its products, the stock rarely looks like a bargain.

In hindsight, Berkshire surely wishes it had loaded up on more shares of Costco back in 2000.

29: Moody’s (MCO)

Percent of Warren Buffett’s Portfolio: 2.4%
Dividend Yield: 0.9%   Forward P/E Ratio: 25.3x   (as of 11/18/19)
Sector: Financials   Industry: Miscellaneous Services
Dividend Growth Streak: 10 years

Warren Buffett bought his first shares of Moody’s back in 2000 around the time that the company went public.

Warren Buffett probably liked Moody’s because of its duopoly position with Standard & Poor’s (regulations have limited the number of ratings agencies), strong pricing power, well-known brand, and essential services (e.g. a company can’t issue a bond without a ratings agency).

Today’s low interest rate environment has led to significant bond issuances around the world, which has helped lift their businesses.

Moody’s continues to be a free cash flow machine and looks to remain a force in the global financial markets for a long time to come.

30: Sirius XM (SIRI)

Sirius is a satellite radio company and was founded in 1990. The company makes money by transmitting a number of premium satellite radio channels on a subscription fee basis to its more than 34 million subscribers. Its content covers everything from sports, music, and entertainment to weather, news, comedy, and traffic. 

Berkshire Hathaway initiated a position in Sirius during the fourth quarter of 2016, but his familiarity with the company dates back much further. Sirius is controlled by Liberty Media Corporation, a company Buffett is also invested in.

What is the key to Sirius’s successful business model? A base of more than 30 million paying subscribers generates healthy recurring revenue, and every incremental subscriber has a high incremental margin. In other words, it doesn’t cost Sirius much to add a new customer, dropping much of the new revenue straight to the company’s bottom line and increasing margins over time.

As penetration rates continue creeping higher and auto sales grow, Sirius’s business will continue expanding. Breaking into Sirius’s relationships with automakers would be extremely difficult, protecting the company. While the rise of digital music services such as Pandora could pose a threat to satellite radio as cars become more connected, Sirius also has its own internet radio service to help it remain relevant.

Investors should note that Sirius only began paying quarterly dividends in November 2016. 

31: Globe Life (GL)

Globe Life, formerly known as Torchmark, is a major provider of life and health insurance products. The company primarily distributes its insurance products through exclusive agency and direct response marketing channels and targets the middle-income market.

Warren Buffett’s stake in Globe Life dates back more than 15 years, and Buffett is no stranger to insurers. After all, one of his most legendary investments ever was Geico.

The insurance business model is an enticing one because insurers receive money upfront when they write new policies, but they don’t have to pay the money back until claims are made.

In the meantime, they can invest policy premiums in bonds and stocks to earn a return. As long as the insurance company is savvy and conservative when it comes to risk management, they can mint money.

As a testament to its sturdiness, Globe Life generated a double-digit return on equity throughout the financial crisis.

Globe Life seems likely to remain in Berkshire Hathaway’s portfolio for a long time to come as it continues compounding its earnings.

32: Visa (V)

Percent of Warren Buffett’s Portfolio: 0.8%
Dividend Yield: 0.7%   Forward P/E Ratio: 28.9x   (as of 11/18/19)
Sector: Business Services   Industry: Financial Transaction Services
Dividend Growth Streak: 10 years

Berkshire Hathaway first bought Visa shares in late 2011. As a long-term investor, Warren Buffett and his team are thinking about what Visa looks like at least 10 years from now. 

They are most likely encouraged by the fact that cash transactions still account for the far majority of total transactions around the world.

33: MasterCard (MA)

MasterCard operates the second biggest payments network after Visa and enables business and consumers to use electronic payments instead of cash and checks.

The company makes money by charging fees to card issuers and acquirers for using its transaction processing services. MasterCard collects a fee based on the number and value of transactions completed using its branded cards.

Closing Thoughts

By remaining focused on simple, high quality businesses trading at reasonable prices, we can construct a sound dividend portfolio that can deliver safe, growing dividend income for years to come.

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How do you know that you are earning enough income to ensure that you can retire? I’m not even considering how to retire early. How do you know that you have enough income to just flat out retire? I’ll highlight one way that allows for you to capture both your retirement AND your income goals. Living off dividends is more realistic than you think. 

Dividends are purely passive income. There is no debate about it in my opinion. You reap the benefits of dividend income after putting in some upfront time to make your investment decision. In addition, you are a minority owner in a business and maintain no controlling-interest decision making. Nor do you have to spend much time managing your investment. Just a few efficient reading every few months.

Thereafter, you can carve out a small amount of time to monitor your investments. With the rise of different mobile apps and speed of information, dividend investing is made for the modern investor for now and into the future.

Is living off dividends possible? 

Historically, dividend investing has been viewed as a way for risk-averse, “belt and suspenders” investors to invest in the stock market. I couldn’t disagree with that mentality more. Dividend investing is one (if not my most) of my favorite ways to increase my income through passive income while also covering off my retirement goals.

Living off of dividends is a marathon. Not a sprint. However, do not take this marathon lightly. You should have the urgency to both increase your income and save for retirement by getting started immediately. The urgency for investing for passive income leads me to one of my favorite sayings:

“The best time to plant a tree was 20 years ago. The second-best time is today.”

Plant your dividend seed now by investing in dividend growth stocks. What will it take? Well, with an average dividend yield (I’ll explain later) of ~3.0% in your portfolio, you’d need approximately a $3.33 million portfolio to earn $100,000 per year in dividend income.

Is it feasible to live off of dividends right away? No. Can it happen over time? Of course. With a prudent plan and strategy, you can achieve the holy grail of passive income…. living off of dividends… sooner than you think. I’ll walk through some steps to help you invest for passive income.

The key to living off of dividends is to focus on dividend growth stocks. Dividend growth stocks increase their dividends annually, which increases our income without doing a single thing.

Remember that saying about planting a seed? Well, it fits perfectly. If you invest the right way your seed will grow into a large redwood tree.

How to build a dividend portfolio for regular income

How do I get started with building a dividend portfolio? I’ve built a great infographic that shows how you should think about building a dividend portfolio. When building a dividend portfolio start scaling in small positions that you will continue to build over time.

First, I suggest you use a brokerage that offers the lowest commissions fee trading available. I currently use Robinhood, which allows me to trade completely commission-free on ALL stocks and options. This is huge because options are usually VERY expensive to trade.

When used properly, options are a great way to mitigate risk in your portfolio, put on a hedge in the case of downside scenario and boost your monthly income from your dividend portfolio. These are the best stocks for covered call writing.

Alternatively, you can use options to increase your income by writing put options. If the stock crosses below the exercise price, you can just buy the stock. This is a great tool to be able to participate in a stock if you don’t know if it will increase in the short-term. Here is a guide to selling weekly puts for income.

If you sign up, we BOTH receive a free share of stock! You can check out our Robinhood dividends guide and review to understand how the app works.

Having your commissions be as low as possible is key to ensure that you are not eroding your returns unnecessarily by paying sunk costs to the brokerages. We want to maximize earning potential for every single penny.

Robinhood has opened the flood gates for investing for passive income. The app has all the necessary news for your stocks right there and it is simple enough to discourage you from trading.

I don’t know about you, but I’m sick of the brokerages pushing retail investors to become traders overnight. With algorithmic trading, the retail investor has no place day trading. The Robinhood app was built for the passive income investor. Here are several other top investing apps to consider.

Dividend portfolio allocation

I suggest the following allocation of exposure to different types of dividend stocks to ensure a successful dividend growth portfolio:

• 20% of your dividend portfolio should be allocated to Dividend Kings
• 35% of your dividend growth portfolio should be allocated to Dividend Aristocrats
• 30% of your dividend portfolio should be allocated to up and coming dividend stocks. We want stocks that have demonstrated a track record of increasing their dividend and rewarding shareholders. These stocks are not considered the ‘classic’ dividend growth stocks like the Dividend Kings or Dividend Aristocrats.
• The remaining 15% of your asset allocation in your dividend growth portfolio should be international dividend growth stocks. You can get a basket of international dividend growth stocks by investing in a global dividend growth fund. Or, you can select individual blue chip international dividend growth stocks.

Keep in mind Dividend Aristocrats have a strong track record of success. Dividend Kings are likely slower growers but have an even better track record of success.

At the end of the day, you should have a robust list of 25-30 dividend stocks to invest in over the long-term.

Once you have your invested dividend portfolio, you take any dividend income received and reinvest into your portfolio of dividend stocks. If you want to live off of dividends in the future, you need to invest the most you can today.

This is equivalent to the savings snowball, but with dividends. Dividend growth investing is a phenomenal way to capitalize on the power of compound interest due to the income potential and the ease of reinvestment into your portfolio.

I keep track of my dividend income and dividend stock prices via Personal Capital. I check this daily and it is completely free.

It’s so satisfying waking up after a weekend of relaxing and seeing $30+ of dividend income hit my dividend portfolio account. I love dividends. Time to go buy more stocks.

Important dividend investing calculations to consider

In general, dividend investing is not very complex. In fact, the simpler you keep it the better you’ll do. Good investing is boring. However, there are several dividend investing calculations that you should consider as you build and monitor your portfolio.

Here are three essential dividend investing calculations that you need to know:

1. Annual dividend yield: Annual dividend yield is the calculation of the percentage of dividend per share received relative to the stock price. This is a great barometer of the annual income you receive from investing in a stock. For example, if you invest in a $50 stock and it pays $2 per share in dividends. This is equal to a 4% annual dividend yield. If you plan on living off dividends, you want the annual dividend yield based on the cost you invested in shares to be the highest as possible.
2. Dividend growth rate: The dividend growth rate for a dividend stock is very important. I love investing in stocks that continually increase their dividend because I essentially get a ‘raise’ every year for doing absolutely nothing. You can calculate the dividend growth rate on any annual timeframe. To do so, take the current year’s dividend per share divided by last year and subtract 1. This will calculate the dividend growth rate compared to the prior year.
3. Dividend payout ratio: The dividend payout ratio is a measure of how much a dividend stock pays in dividends relative to their earnings. You must consider the payout ratio of a stock because a high payout ratio means the company is retaining limited cash to be reinvested in the business. This can sometimes flash a red flag. If earnings decline, the dividend stock will have to decrease their dividend. That goes completely against our rules. We only want stocks that we know no matter what they will (at a minimum) maintain their dividend or increase it over time.

If you want to live on dividends, you must focus on the income component first. Make sure that the dividend will never decrease in value.

You need stability of the income and stock appreciation. Good stocks increase their dividend over time and the stock value appreciates as well. This is since the earnings are likely increasing as well.

Also, understand that you are lowest priority in the capital stack in the event of a liquidation since you are an equity investor.

You can track these statistics easily with sites like FINVIZ. GuruFocus or Investopedia. Sign up for GuruFocus and we will both get a free month of premium. I love their guru investor trackers to search for new investment ideas.

Once I find a new investment idea, I like to do a quick-and-dirty analysis with our free downloadable dividend discount model.

Use the three ratios to start building your dividend portfolio and choosing the right stocks for you, so… what dividend stocks should you look for?

Let’s evaluate how to live off of dividends.

Identifying the best long-term stocks for dividends

I’ve read tons of investing books including those from Benjamin Graham, Warren Buffett, David Einhorn and other legendary investors. One common parallel among them all is the notion that you should only invest in stocks that you understand.

I like to invest in businesses that I understand at undervalued prices.

I love running my stocks through a qualitative analysis that features a series of yes/no questions, including but not limited to:

1. Shareholder Friendly: Has the company increased its dividend in the last 3+ years? (Yes or No)
2. Financial Health: Does the Company have a modest dividend payout ratio? (Yes or No)
3. Management Team: Was the current CEO hired internally? (Yes or No)
4. Operational Excellence: Do they have a track record of revenue and earnings growth? (Yes or No) Has the company provided a long-term growth plan? (Yes or No)
5. Business Model: Do you understand the business model? (Yes or No) Is there a significant moat around the company? (Yes or No)

Think of each ‘Yes’ answer as 1 point to your score. You certainly cannot have more than half of your questions answered as ‘No’ if a company is going to become a dividend growth stock for the long haul. Living off dividends means that you are positioning yourself for the best future success possible. That means you need to be invested in the best performing stocks of the future.

Even a better scenario would feature an outcome where you are a frequent customer of the company. Warren Buffett has been an investor in Coca-Cola since 1988 / 1989, which has generated over a +1,595.58% return since that time. Warren also drinks at least one Coca-Cola per day. This is a great example of dividends and dividend growth investing.

Talk about putting your money where your mouth is… If you want a visual depiction of how we look for stocks.

Check out my dividend stock screener infographic.

5 Steps to Invest for Passive Income with the Goal of Living Off Dividends

If you follow the rules for finding the best stocks for dividends, your dividend investing will be passive. As you build your portfolio over time, there is limited work needed to be done. All you need to do is ensure you have real-time notifications enabled for your dividend portfolio.

Can you earn passive income from investing? Absolutely, all you is follow these five steps to achieve the ultimate goal of living off dividends.

1. Contribute $200 per month to your dividend portfolio your first year

Set up an automatic contribution of $200 per month to your dividend growth portfolio. That should be an easy start. If you want to contribute more, even better! Make your contributions automated as much as possible. We want to save our time for other sources of passive income.

2. Increase your monthly contributions by 25% per year

This sounds like a lot but can be doable so long as you increase your income from other sources along the way. As long as you are a good saver, you should be able to do this for the first 10 years. After that the annual increases get much more difficult, but they are certainly attainable. I’ve been saving at least 30% of my after-tax income each year.

3. Any dividend income you receive should be reinvested into your dividend growth portfolio

Once you receive dividend income, use this to buy more stock in your portfolio. Rather than a dividend reinvestment plan, I like to invest at my own discretion. A dividend reinvestment plan will automatically buy shares in that specific stock. Without the dividend reinvestment plan, I can invest in a stock when it declines in value or I can invest in a different dividend stock in my portfolio.

4. Invest in quality stocks that enable you to achieve a 6% growth rate in your equity value

This point shouldn’t be hard to do. You will have some winners and some losers, but just make sure you have 6-8 winners out of every 10 stocks.

5. Repeat steps 1-4 as you go over time

Continue with your plan and it will all work out. I like building a hand selected version of dividend stocks as opposed to index investing. This allows me to focus on specific yields and invest in companies at attractive valuations.

So, how do you truly get to the point of living off dividends?

Let’s look at a case study that validates the fives steps to living off dividends forever that I highlighted above.

This is bound to convince you that living off of dividends is realistic. If you follow the five steps to investing for passive income, you will see the amazing effects of the following:

1. The power of compound interest
2. The ability to achieve two goals in one… Your portfolio value increases over time AND you increase your income significantly
3. By year 20, you have achieved a ~$100,000 annual passive income and an aggregate portfolio value of over $3 million dollars

Let’s get into our case studies surrounding what it takes to live off dividends.

Scenario #1: Start off by Contributing $200 Per Month to Your Passive Income Dividend Portfolio

In the graph below, I show that you contribute $200 per month in your first year for a total annual contribution of $2,400. From there, you increase your annual contributions by 25% per year. Your portfolio appreciates in value as stocks increase in price at a rate of 6% per year.

Your dividend income received is 3% per year, which is very attainable. This is slightly above the average yield for the S&P 500.

You can achieve a $100,000 passive income per year and a multi-million dollar portfolio.

Scenario #2: Start off by Contributing $500 Per Month to Your Passive Income Dividend Portfolio

In the graph below, I show that you contribute $500 per month in your first year for a total annual contribution of $6,000. From there, you increase your annual contributions by 25% per year, but you max out your contribution $69,849 in year 11 and maintain that annual contribution thereafter.

This assumes the same assumption that your portfolio appreciates in value as stocks increase in price at a rate of 6% per year.

Your dividend income received is 3% per year, which is very attainable. This is slightly above the average yield for the S&P 500. This results in you achieving the same mark but contributing less in total contributions of only $953,889 total contributed in 20 years.

This scenario results in $90,000 annual income and a $3 million portfolio value.

Test you own case studies by using our dividend calculator to calculate the future value of your portfolio and income.

You can download the dividend calculator below:

Click here to download

Key Takeaways from the Living Off Dividends Scenarios

A key takeaway for how to live off of dividends is twofold.

1. Increasing your income and savings over time is paramount. You cannot reach maximum goals if you do not continually increase your income. If you don’t increase your income you can rely on my next point for living off dividends. You can increase your income by investing in real estate income properties. Or, you can increase your income without working more.
2. Start early. You need to contribute as much as possible to your dividend portfolio as early as possible. From there, you should maintain an annual increase in your contributions. Stay organized and keep a log of your contributions and when you are due for an annual increase.

Investing for passive income should not be taken lightly though. You simply do not just invest in dividend stocks blindly. Get involved and stay focused on improving over time.

You should do your own due diligence in stocks that you invest in. The better you are at your due diligence the more your investment returns should increase. Imagine if your portfolio value increased at an annual rate of 10% per year. The benefits can be significant.

Are you going to start investing for passive income?

My case study shows that investing for passive income is achievable for anyone. More importantly, it shows that dividend growth investing for passive income is MOST IMPORTANT for the younger generations.

If all you need is 20 years to become a multi-millionaire that receives a six-figure income for doing absolutely nothing, you can retire safely at age 41 so long as you start at age 21….

Simply amazing.

On a time-adjusted basis, dividend investing is one of the most attractive value propositions out there. No questions asked.

Dividend investing is a way to earn passive income without working at all. Take the time to pay yourself first by investing to live off of dividends. Use dividend income tracking software to know when your dividends will come in. This will help you continually deploy additional capital.

Dividend investing opens the door the following considerations that are not commonly found with other passive income ideas:

• Obtain unlimited upside potential by investing in high-quality dividend stocks
• Realize the benefits of monthly or quarterly income
• As Albert Einstein once said, “Compound interest is the eighth wonder of the world.” Dividend investing is the best way to capture compound interest over the long haul and maximize your total return.

What will you do next to live off dividends?

Keep in mind dividend investing is additive to your current retirement goals. You should be contributing the max amount to your 401(k) and maxing out your Roth IRA / IRA annually. Then, proceed with a dividend investing portfolio. Start investing and evaluate what it will take for you to retire early.

If you want to retire early, you’ll need to supplant your current income since your retirement accounts cannot be touched until your later years. By building a successful dividend portfolio, you’ll earn additional income that also features residual value once you hit your age threshold for your retirement accounts.

I use Blooom to do a free 401(k) and IRA analysis to determine my proper allocation. This has been very helpful for me as I continue to invest in index funds for my 401(k) and focus on increasing my income with a dividend growth portfolio. You can live off dividends in early retirement and retirement.

Disadvantages of dividend investing

There are some things to consider as disadvantages of dividend investing. I always like to consider the cons side of the equation with investing for passive income. You tend to learn a lot more from the cons to strengthen your story on the advantages.

• Taxes associated with dividends: Oftentimes, we are taxed at a much higher bracket. If you are a high-income earning (like myself), you effective tax rate is 40-50% on your dividend income. I am taking a small hit on my taxes for a huge benefit for the future.
  • Taxes associated with dividends debunked by Millionaire Mob: We are investing for dividend growth people. I hope that you are buying stocks now that will increase their dividend significantly over time.
  • I don’t invest to increase my current income today. I increase my current income for tomorrow (aka early retirement). In addition, with dividend investing for passive income, we are striving to achieve our goal of early retirement. When we retire early by living off dividends, our tax bracket decreases significantly.
•  Total return is always better: Another disadvantage of dividend investing for passive income is the fact that companies are usually better off investing that cash back into their business. I’ve seen a few articles arguing that Warren Buffett’s Berkshire Hathaway doesn’t pay a dividend for a reason.
  • Cash reinvested by companies’ debunked by Millionaire Mob: Berkshire Hathaway is an investment company. For people that believe it is a conglomerate is purely wrong, Berkshire Hathaway is an investment manager.
  • They acquire and invest in high-quality businesses to generate a return for their shareholders. In order to maximize the return, they invest every dollar of capital into these businesses to take advantage of compound interest. Yes, there are instances where companies are better suited to reinvest all cash into the business. Warren Buffett is a great example. He has led by example on this effort and by my book, he deserves to invest every dollar into dividend-paying companies. Warren Buffett loves dividends.
  • Further debunked myth, companies are generally not better off reinvesting cash back into the business. How about Twitter acquiring Vine just to shut it down? Prudent use of cash? Highly doubtful. Huge CEO bonuses are a prudent use of cash? I don’t think so.

Here are a few comparison points to consider.

The advantages of investing for passive income far outweigh the disadvantages. I love dividends. I also love increasing my nest egg for retirement. At some point, I will be able to live off my dividends completely. At the right time, you can then sell the dividend stocks in your portfolio to live off of that nest egg for the rest of your life.

I’ve highlighted why I believe you want dividends over growth investing. A growth stock is a share in a company whose earnings are expected to grow at an above-average rate relative to the market.

Growth stocks don’t typically pay dividends, because the companies would much prefer to reinvest the earnings in their own company. These stocks are a little riskier since they are reinvesting cash flow into a business that is unsure of proper capital allocation. Dividend stocks are proven companies that continue to deliver excellent financial performance.

Back to that killing two birds with one stone…

I love dividends

Fund managers and institutional investors love dividend paying stocks. Companies that pay dividends are a vote of confidence to the professional investing community that they are confident in their ability to increase earnings and confidence in their ability to increase their dividend. A win-win around the table.

Share repurchases also signal confidence but offer more flexibility because they don’t create a tacit commitment to additional purchases in future years. When you get both share repurchases and dividends, you unlock some outstanding benefits.

For now, continue to invest in a dividend portfolio to increase your income AND save for retirement. Your future self will thank you. You’ll want to track your dividend income using these software tools.

I love dividends so much that… I created a book called Dividend Investing Your Way to Financial Freedom

I think dividend investing is often misrepresented amongst the investing and financial freedom community. There is so much to learn from dividend investing and my approach.

Dividend investing is a fantastic way to build wealth through compound interest. Dividend investing is not the only strategy in the world. However, I believe that if you can combine value investing with dividend-paying stocks, you can achieve a compelling total return.

I created a dividend investing book to help you:

• Improve your portfolio returns
• Understand the pros and cons of a dividend investing approach
• Develop and craft your own dividend investing strategy
• Build wealth through a long-term compound interest plan

That is why I created Dividend Investing Your Way to Financial Freedom.

I’m finally ready to launch my first dividend investing book.

You can buy the book on Amazon

Check out on Amazon to buy the book if you wish! I think you will learn a lot. If not, here are 12+ other top dividend investing books to consider.

Follow Millionaire Mob’s dividend growth investing journey

Follow along on my dividend growth investing journey to get the latest and greatest updates on our dividend growth portfolio. I am building a dividend income portfolio from scratch that everyone can follow along.

Passive income dividend investing takes a lot of upfront work, but features massive benefits.

Are living off dividends? Do you have any questions that you’d like addressed? Let me know in the comments below. I’d love to hear from you. Our wealth management resources will help you plan and execute on your financial future. Good news is that they are all free.

Related Resources

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While each of us will ultimately reach different conclusions and asset allocations, we are united by common desires – to maintain a reasonable quality of life in retirement, sleep well at night, and not outlive our savings.

Living Off Dividends: The Benefits of Dividend-Paying Companies

This contrasts sharply with a systematic withdrawal system for retirement income. Which situation sounds more stressful – the investor who lives off cash flow produced and distributed by his investments each month, or the investor who must select assets to sell in order to generate enough cash flow each year?

Living on dividend income in retirement provides cash without incurring the stress of figuring out which assets to sell and when, especially if another market crash is around the corner.

Once again, the focus can remain on locating safe dividend payments rather than getting concerned with the market’s price volatility and how that might impact your withdrawal amounts. As long as there is no reduction to the dividend, income keeps rolling in regardless of how the market is behaving.

A great example is our Conservative Retirees model dividend portfolio in our monthly newsletter. While the S&P 500 Index plunged more than 50% during the financial crisis, the stocks we hold would have delivered steady dividend income during this period.

Another benefit of owning dividend stocks in retirement is that many companies increase their dividends over time, helping offset the effects of inflation. 

According to the Wall Street Journal, over the past 50 years the S&P 500’s dividends grew at an average 5.7% per year, outpacing the average 4.1% inflation rate. While past performance is not necessarily indicative of future results, retirees who depend on a meaningful amount of dividend income are likely to be in a good position to protect their purchasing power with the right dividend stocks.

Additionally, a dividend investing strategy preserves and grows your principal over long periods of time, unlike most annuities and withdrawal strategies. This allows you to leave a legacy for your family or favorite charities. Dividend investing also provides flexibility to sell off assets if you need to fund special retirement activities or offset some unexpected dividend cuts. Once again, annuities typically lack this flexibility.

Importantly, dividend stocks have contributed substantially to the market’s total return over time, playing a very important role when it comes to capital preservation and growth. From 1930 through 2017, dividends have accounted for approximately 42% of the S&P 500 Index’s total return, per the Hartford Funds.

But what does that really mean? Well, suppose you made two $10,000 investments into the S&P 500 back in 1960. One investment received no dividends. Its value was completely driven by the rise (or fall) of the market.

The other $10,000 investment received dividends paid by the S&P 500 companies, reinvesting the payments back into the S&P 500 as they were received.

The latter investment grew to more than $2.5 million by the end of 2017 compared to less than $500,000 for the other investment. Dividends matter.

As you might have noticed in the bar chart above, the relative importance of dividends varied from one decade to the next depending on the strength of the market’s price performance. During periods when stock prices stagnate, such as the 1970s and 2000s, dividends make up a greater portion of the market’s return than capital appreciation.

With the market trading at a historically elevated earnings multiple today, making significant capital gains harder to come by, dividends seem likely to account for a meaningful proportion of the market’s total return over the next decade.

Either way you look at it, stocks are much more attractive than bonds in today’s market environment. The financial world has changed a lot over the last 40 years. As you can see, long gone are the days of double-digit bond yields. Many quality stocks now yield significantly more than corporate bonds.

As Warren Buffett stated in May 2018, “Long-term bonds are a terrible investment at current rates and anything close to current rates.” 

Why the hate for long-term bonds? Like many things, it’s simple math for Buffett. Long-term bond yields are 3% today, and their interest income is taxable at the Federal level. In other words, their after-tax yield is about 2.5%.

Meanwhile, the Federal Reserve is targeting 2% annual inflation. So the long-term bonds’ after tax return, adjusted for inflation, is approximately 0.5% per year. 

As Buffett put it, long-term bonds at these rates are “ridiculous.” It’s hard to disagree when you consider that long-term stock returns are close to 10% per year, and, unlike bonds (which make fixed interest payments), dividend stocks grow their payouts. 

Besides fueling healthy long-term returns, dividend investing has historically exhibited less volatility than the broader stock market as well.

As seen below, dividend-paying stocks in the S&P 500 Index have recorded significantly less volatility (i.e. a lower standard deviation) than non-dividend paying stocks over the last 45 years.

“My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers…

Both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.”

The average fund tracked by Morningstar charges about 1%, according to The Wall Street Journal. If a $1 million portfolio was invested in the average mutual fund, it would pay $10,000 in fees, which grow as the account’s value rises.

Suppose the $1 million was invested in a dividend-focused fund yielding 3.5%. Over 28% of the $35,000 of dividend income generated would go towards fees.

But what about some of the low-cost dividend ETFs with fees as low as 0.1%? In many cases, investors who are less willing to commit the time or lacking the stomach to buy and hold dividend stocks directly would be wise to evaluate such funds for their portfolios.

However, they lose a valuable benefit: control.

Specifically, almost all ETFs own dozens, hundreds, or even thousands of stocks. Vanguard’s High Dividend Yield ETF (VYM) owns over 350 companies, for example.

Some of these are good businesses with safe dividends, while others are lower in quality and will put their dividends on the chopping block. Some have high yields, others hardly generate much income at all.

Simply put, an ETF is a hodgepodge of companies which may or not match your own income needs and risk tolerance very well.

Vanguard’s High Dividend Yield ETF got into trouble during the financial crisis because it was not focused on dividend safety. The ETF’s dividend income dropped by 25% during this period and took four years to recover to a new high.

Hand-picking your own dividend stocks with a focus on income safety can deliver higher, more predictable, and faster-growing income compared to most low-cost ETFs. You will also better understand all of the investments you own, helping you weather the next downturn with greater confidence. 

Risks of Living on Dividend Income

Closing Thoughts

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