Borrowing today for retirement dividend income tomorrow

This is quite similar to a series to inaugural articles (leverage series) I wrote on how you might still retire in comfort, even if you're in your mid-40's and have little savings, but do have some decent home equity.

It's based on using dividend income to make mortgage payments on an increased amount, and by the gambit of the dividend increasing, paying off the mortgage by the time retirement looms, and being left with a nice steady stream of dividend income. The one nice thing about dividend income is that, for most companies, it tends to rise over time. The assumption here is that the dividend income will rise by about 3.5% per annum over time, and that you have chosen a mortgage allowing generous repayment privileges, thus allowing you to increase your mortgage payment as your dividend income rises.

Let's assume you take out a 30 year amortization mortgage for $100,000, with at a rate of 5.03%, which Zillow.com reports is the national average this past week. That leaves you with a monthly payment of $539 per month ($6,464 annually).

Using a stock screener and the ratings at Morningstar.com, you can come up with a relatively safe selection of higher yielding stocks. What we are looking for here, are large company stocks, with relatively high yield, which look like they will still be prosperous in 20 years. Not superstar, super-growth stocks, nor stocks that yield so high that one questions their survival, just large, solid companies in relatively stable sectors.

Using that rationale, and also trying for modest diversification as well, I arrived at the following list (Company Name, Symbol, Sector, Closing Price [Dec 31 2009], most recent quarterly dividend, forward annual dividend rate [based on quarterly x 4]):

1. Altria, MO, Tobacco, $19.63, $0.34, 6.9%


2. Reynolds, RAI, Tobacco, $52.97, $0.90, 6.8%


3. Integrys Energy Group, TEG, Utilities, $41.99, $0.68, 6.5%


4. Health Care REIT, HCN, Real Estate, $44.23, $0.68, 6.1%


5. AT&T, T, Telecom, $28.03, $0.42, 6.0%


6. Verizon, VZ, Telecom, $33.13, $0.475, 5.7%


7. Eli Lilly, LLY, Drugs, $35.71, $0.49, 5.5%


8. Bristol Meyers Squibb, BMY, Drugs, $25.25, $0.32, 5.1%


9. EI du pont, DD, Materials, $33.67, $0.41, 4.9%

On average, these stocks yield 5.95%, and assuming an equal-weighted purchase, the current annual dividend payments ($5,945 annually), would leave a modest initial annual shortfall of $519 which would need to come out of your pocket for the first few years. Assuming that the dividend increases average a modest 3.5% annually, by year 3 or 4 you would not have to subsidize your mortgage payment.

With the rising dividend payments, assuming you used the extra cash-flow to slash away at the mortgage, by year 20 year your mortgage would be paid off, leaving you with a nice fat stream of dividend income which would now be about $11,800 annually. If you were 45 today when you started this strategy, it would nicely dovetail with a retirement at 65.

Not only that, but the value of your stocks may well have doubled too, and you can likely look forward to the income stream increasing further into the future.

As a variant on the same strategy, if you can swallow a bigger negative cash-flow over the first five to ten years, you could well select stocks that have better dividend growth prospects, but start at a lower yield. By the time 20 years rolls out, that strategy is likely to have produced a higher total return and dividend income at that time.

As I suggested when I first wrote a similar series of articles, this is a strategy which can rarely be employed, usually because mortgage rates are higher than dividend rates for these type of companies. This situation won't last very long (i.e. probably less than one year). See your advisor soon if you are considering this move.

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JW

The Confused Capitalist