Book Review: How to Retire On Dividends

It has been a while since I read for pleasure. I used to be an avid reader in my early adulthood. But that changed as my career and hobbies took over. Recently, I made it a personal goal to start reading personal finance books. Late last year, I signed up for a free 3-month trial of Kindle Unlimited. The idea is that it’s similar to a digital library and you can read any book in the Kindle Unlimited catalog. Unfortunately, I didn’t find many good books that I was interested in reading. The Kindle Unlimited catalog is filled to the brim with romance novels. This past Prime Day, I was eligible for another 3-month trial of Kindle Unlimited and I found a few personal finance books that sounded interesting.

Recently, I read “How to Retire on Dividends: Earn a Safe 8%, Leave Your Principal Intact” by Brett Owens and Tom Jacobs. Both of the authors are involved in producing the Contrarian Outlook newsletter and the Contrarian Income Report subscription. The book was written pre-pandemic when interest rates were historically low and price-to-earnings were high after a decade-long bull run. The S&P 500 didn’t, and still doesn’t, pay much in passive income. Bond funds didn’t pay much either due to low-interest rates. As people enter retirement, they need to live off of their nest egg. Since people are living longer, that nest egg needs to last. If dividends aren’t sufficient to fund retirement, people will have to withdraw from their principal. And as that principal declines, so do the following year’s dividends. The authors call this reverse dollar-cost averaging. The authors propose that people build a portfolio, known as the No Withdrawl Portfolio, that pays high dividends where they never have to withdraw from their principal.

The authors suggest that you invest in undervalued but high-quality stocks and bonds that pay high dividends (6% or higher). This way you will continue to receive dividends but also gain from price appreciation. As long as the dividends grow or remain the same, you will never have to withdraw from your principal. It doesn’t matter whether the price goes up or down as long as the dividends keep coming because you will never withdraw from the principal.

The authors state that the big financial companies can’t recommend the types of equities they do because of two reasons. The first is that large financial companies have too many clients and won’t be able to provide custom portfolios for everyone. Instead, clients answer a risk assessment questionnaire and are provided a pre-built portfolio that other clients with the same risk profile receive. The second is that large financial companies are required to buy investment-grade quality equities. This usually means a portfolio of large-cap stocks. Investing in smaller companies with lower investment-grade ratings will move the price too much. This limitation also means that returns are modest.

So where should one invest to get high returns on relatively safe investments? The authors suggest a 50/50 mix of 15-20 stocks and bonds as opposed to the normal recommendation to invest the same percent of bonds as your age. They suggest this because they believe that you need portfolio growth even in retirement. For bonds, they prefer closed-ended funds (CEFs). CEFs are actively-managed, meaning you will have to pay a relatively high management expense ratio (MER) compared to indexes, but with those fees comes the knowledge and expertise of the CEF manager. Each CEF has a net asset value (NAV). The goal is to find a high-quality CEF with an experienced manager that is trading below NAV and pays a high dividend. If you buy a CEF that is trading below NAV, you essentially get the CEF manager for free. One of the biggest differences between a CEF and an ETF is that the manager can’t create new shares. As a result, there is less liquidity but the authors think that this is a benefit because it means less volatility. When markets are in turmoil, it is easier to make a run on bond ETFs when there is sufficient liquidity, but this is less likely to occur with a CEF. CEF managers can access underlying investments that larger investment firms can’t access, like those with a BBB rating, because of the requirement to invest in investment-grade equities.

For stocks, the authors prefer real-estate investment trusts (REITs). They are wary of betting against Amazon, so they recommend REITs in areas where Amazon doesn’t compete, such as healthcare, industrial, and commercial loans. As many have warned, be wary of companies that have high payout ratios because they’re usually signs that the dividend will be cut. A company where the net income doesn’t cover the dividend has to take on debt to continue to pay the dividend. REITs are required by the government to pay most of their earnings in dividends. The authors suggest that a good dividend-to-FFO (funds from operations) ratio is 80% or less.

While the premise is intriguing, I didn’t like this book. What I didn’t like the most about the book were the examples that they used. They showed graphs where Dividend Aristocrats performed poorly over a period, where one fund performed poorly compared to its CEF equivalent, etc. But you could reach the opposite conclusion by choosing a different period. The authors admit that some of the equity choices don’t do well in high-interest rate environments, but then go and show how they performed well during a period of high-interest rates before the 2008 financial crisis. I’m curious how their portfolio is faring in today’s high-interest rate, high-inflation environment. A member of a forum that I frequent suggested that the current portfolio is heavily weighted toward bonds.