As 10,000 Baby Boomers per day reach retirement age, the question of how Americans will be able to afford a comfortable lifestyle is among the most important of our age.

Over the past several decades, plenty of academic studies have been done looking at several approaches to funding retirement via different investing approaches.

Let’s take a look at what some of these options are, including how a long-term dividend growth portfolio can help investors achieve true financial independence in retirement.

The Major Problem Facing Retirees
Financial advisors generally say that people should save 10% to 15% of their income in order to save for retirement. However, as you can see, in recent decades Americans’ personal savings rate has fallen drastically to around 5%.

Source: St. Louis Federal Reserve

Combined with a decline in company-sponsored pensions and the rise of defined contribution plans (IRAs and 401Ks), tens of millions of Americans have been left to fend for themselves when it comes to saving and investing for their futures. However, one of the problems is that the average individual investor generally underperforms the market due to destructive financial psychology that results in a misguided desire to time the market.

Source: BlackRock

The net result of these historical trends is that a vast swath of Americans are way behind on saving for retirement. In fact:

  • 34% have no retirement savings
  • 25% of Americans have less that $1,000 saved for retirement
  • 50% have less than $25,000

In fact, according to a recent study by GoBankingRates.com, about 50% of Americans will retire with insufficient retirement savings.

Source: GoBankingRates.com

But just how much do you need for a decent lifestyle in retirement? Well the answer of course is complicated by your age, where you live, cost of living, and lifestyle choices. However, in general a conservative rule of thumb, assuming retirement age of 65 and income replacing 75% to 80% of your peak earnings (with 20% provided by Social Security), is as follows:

Charles Farrell, Northstar Investment Advisors, LLC.

Why Traditional Options May Not Work
Keep in mind that these figures assume a 30-year retirement and that you will sell 4% to 5% of your portfolio each year. However, if you’re one of the millions of Americans with vastly underfunded retirement savings, than this strategy simply won’t work.

[ad#Google Adsense 336×280-IA]After all, if your total retirement nest egg is $100,000 by the time you plan to retire, than $4,000 or $5,000 in annual income ($333 to $417 per month) just won’t be enough to augment the average monthly Social Security Benefit of $1,407 in 2016.

That means that there are few options other than to continue working and saving, as well as waiting until age 70, when you can maximize your Social Security benefits and hopefully have a large enough retirement account to make ends meet.

Longer lifespans also mean that, depending on your current age, you might be facing a longer retirement than you initially planned for. For example, if you are 60 years old today, than you have a 20.5% and 32.2% probability of living to 90 years old if you’re a man or woman, respectively, according to the Social Security Administration.

In addition, we can’t forget that the traditional 4% rule, in which you withdraw 4% of your retirement savings each year, can sometimes result in poor luck. That’s because the stock market, despite being a great long-term wealth compounder, can be highly volatile over short periods of time.

For example, in 2000-2003 and 2007-2009, the market crashed by 50%. If you happen to be retiring at this time, than the amount of retirement income you would be receiving would likely be far less than you may have planned for.

Despite a potential lifelong dedication to long-term buy and hold investing, short-term market conditions could still potentially have a deleterious affect on your standard of living during retirement, in addition to triggering strong emotions that could lead to harmful investment behavior.

Given today’s extremely low savings rates near 0% and some of the unique challenges of the 4% rule, many income investors have turned to dividend growth stocks to help fund their retirements. This approach can help retired investors earn higher current income without having to worry so much about the market’s short-term volatility and day-to-day movements in share prices.

How Dividend Growth Investing Can Help in Retirement
Since 1871 the U.S. stock market has generated 9.1% annual total returns, 52% of which are due to dividends and dividend reinvestment. The benefit of dividends is that they can provide you with a steady and growing stream of income (often offsetting inflation) that can allow you to live off the income stream and avoid having to sell shares of your retirement portfolio.

In other words, if you are careful about what you invest in, then your future prosperity can become largely independent of share prices; even a 50% market crash at the worst possible time won’t hurt your retirement plans, assuming you have invested in a well diversified portfolio of companies that can collectively continue paying safe dividends.

That’s because certain blue chip dividend growth companies, such as dividend achievers, aristocrats, and kings, generally have wide moats, predictable business models and cash flows, and conservative management teams committed to paying reliable dividends. A market correction or temporary dip in the economy is unlikely to eliminate their dividend payments.

However, only when we look at the long-term wealth and income compounding power of dividend investing can we really see how dividend investing can help develop a healthy monthly income stream for one’s golden years.

As you can see from the table below, which uses historical performance and yield data from the PowerShares S&P 500 High-Yield, Low Volatility ETF (SPHD), long-term dividend growth investing has been an appealing way to secure yourself a private pension – one that can potentially generate meaningful amounts of income with as little as 10 to 15 years of consistent savings and investment.

Source: DividendChannel.com

The key is to start early, dollar cost average (invest each month regardless of what the market is doing), and reinvest the dividends. It also assumes that you can withstand the market’s occasional gut-wrenching volatility and avoid the pitfalls of market timing, specifically selling during a correction, bear market, or crash.

But what if you don’t have 20 years left before retirement? In that case, dividend investing can still help because it’s a flexible investment strategy – with thousands of companies paying dividends, a portfolio can be customized for many unique income needs and risk tolerances.

For example, while the above table assumes a yield of 3.5%, by carefully selecting safe, low risk, high-yield stocks, you can achieve a somewhat higher-yielding portfolio without being irresponsible with risk.

Limitations of Dividend Investing
While dividend growth investing is a popular and often effective component of a diversified retirement portfolio, that doesn’t mean it’s a silver bullet. For one thing, dividend investing depends on the broader stock market’s long-term compounding power, which means that its potential benefits rely on three things: discretionary income, discipline and consistency, and most of all, time.

For example, say that you estimate that you’ll need $50,000 in annual dividends to supplement Social Security payments and live comfortably. If up until now you’ve been saving nothing and now have just five years until retirement, than you’d have to save $12,410 a month to get to the $1 million needed, assuming a 5% portfolio yield.

Sources: Dave Ramsey Investment Calculator

That’s a huge burden that very few people could shoulder. On the other hand, if you have 20 years until retirement (e.g. you’re 50 and plan to retire at 70), then less than just $1,324 per month in savings and investing can likely get you close to your goal.

That’s the power of compound interest and exponential growth. It’s such a powerful concept that Albert Einstein is said to have called it “the 8th wonder of the world..” Unfortunately, exponential growth is something that humans have a hard time conceptualizing and so many people fail to take advantage of it.

Of course, having strong enough personal finances to be able to invest these kinds of amounts is easier said than done for millions of Americans who are struggling to make ends meet or who carry a lot of debt.

For example, for those who carry credit card debt (an average of $16,748), it’s vital to pay these high interest rate balances off as soon as possible. That’s because the interest rates on credit cards can be as high as 30%, a level that almost no investors can ever achieve over the long-term (Warren Buffett’s 50-year annual return is 20.8%).

In addition, a large number of Americans approaching retirement age still owe large amounts on their mortgages, a trend that has been rising over time.

Percentage Of People With Mortgages By Age

Average Mortgage Size by Age

Source: Money-Zine.com

If you are in one of these unfortunate positions with a lot of debt, than you may want to consider talking with a financial advisor to work out a plan that balances paying off your debt by retirement, while still maximizing how much you can save and invest over time.

In other words, the first step on the road to financial security and a prosperous retirement is getting your personal financial house in order. Specifically: living beneath your means (so you can afford to save and invest), having an emergency fund (3-12 months of expenses) in order to avoid getting trapped into high interest credit card debt, and a willingness to ignore the daily noise of the markets (avoid market timing).

While doing this isn’t always easy, it’s the best bet that regular Americans have in order to build a large nest egg and achieve the financial freedom that comes from a safe and growing dividend stream.

Concluding Thoughts On Dividend Investing and Retirement
In today’s uncertain world retirement can be a frightening concept, especially for those Americans struggling with increased job uncertainty, high debt loads, and a ticking retirement clock.

However, high-quality dividend growth stocks, coupled with a plan to consistently save and invest in a diversified portfolio, are foundational components of almost any financial plan designed to achieve a comfortable standard of living, especially during retirement.

Brian Bollinger
Simply Safe Dividends

Simply Safe Dividends provides a monthly newsletter and a comprehensive, easy-to-use suite of online research tools to help dividend investors increase current income, make better investment decisions, and avoid risk. Whether you are looking to find safe dividend stocks for retirement, track your dividend portfolio’s income, or receive guidance on potential stocks to buy, Simply Safe Dividends has you covered. Our service is rooted in integrity and filled with objective analysis. We are your one-stop shop for safe dividend investing. Brian Bollinger, CPA, runs Simply Safe Dividends and previously worked as an equity research analyst at a multibillion-dollar investment firm. Check us out today, with your free 10-day trial (no credit card required).

Source: Simply Safe Dividends