Editor's note: This is the first article in a three-part series on an investment strategy built on dividend-growth equities.
The aging baby boomers are changing everything ... again.
In the 1950s, they changed the structure of American education. In the 1960s, they changed the country's residential landscape. In the 1980s and 1990s, they discovered "growth" stocks. In 2000, they discovered risk and, in response, diversification. Over the next 20 years, they will discover portfolio dividend income and dividend growth.
It has been an oft-repeated mistake to assume that baby boomer demand will mirror their parents' at the same age. Boomers never graduated to Montovani; they still like rock 'n roll. They don't dress as their parents did; they prefer blue jeans. They don't join the same clubs or activities; they design their own. Boomer parents grew old gracefully; boomers are aggressively fighting the aging process with Botox, exercise and artificial hips. In fact, the one constant through all these life cycles is that boomers do not want to be like their parents.
Why, then, do so many investment advisers expect boomers to seek the popular retirement investment solutions of the distant and, even, recent past? We see it every day. It is assumed that as they age, boomers will want more bonds and fewer stocks, just like their parents. It is assumed that the risk-management solutions of the present, like broad asset class diversification, will meet the needs of the boomer future.
But they won't. Bonds are poor antidotes to inflation; the purchasing power of the fixed interest and principal payments will be eroded by inflation. Broad asset class diversification inhibits the generation of what boomer retirees most need, portfolio income and portfolio income growth.
Boomers look for portfolio 'purchasing power'
As they approach retirement, boomers will not think in terms of allocations to stocks and bonds; they will think about portfolio "purchasing power." Can my portfolio consistently pay for my desired lifestyle, in an inflationary environment? Can it provide lifestyle protection even when markets turn down? Can it maintain my desired standard of living for a long life expectancy and for one that is will probably be even longer due to future medical advances?
Boomer retirees will need a full measure of predictable portfolio income and a full measure of appreciation potential. 50 percent allocated to fixed income will not generate the needed income stream; 50 percent allocated to "growth" equity styles and asset classes will not deliver the growth and stability needed for a 25+-year life expectancy.
The needed investment style is one that generates a lot of portfolio income, today and tomorrow, and is fully committed in investments with appreciation potential. Bonds deliver income, but have uncertain appreciation potential. Stocks that pay no dividends may have volatile appreciation potential, but no current income. The compelling solution is dividend-growth common stocks; those that deliver income, those that deliver annual income increases, and those that maintain a full measure of price appreciation potential.
Portfolio income matters
The historical long-term value creation of a diversified dividend growth and income strategy can be demonstrated in the following back test of alternative portfolio strategies. In this chart, the dividend-growth portfolio consists exclusively of all domestic equities that, at the time of inclusion, had uninterrupted annual dividend growth of at least 10 years. (Past performance is no guarantee of future returns.)
There are several points of interest in the above historical analysis.
First, portfolio income has mattered; the total portfolio value growth was reasonably correlated to the portfolio income generation. The highest income generator, "dividend-growth," delivered the highest total returns; the lowest income generator, gold, delivered the lowest total returns.
Second, the steady and growing dividend income stream of the "dividend-growth" portfolio clearly offered steady and growing portfolio purchasing power.
Third, no consistent combination of the portfolios shown would have done better than the "dividend-growth" hypothetical portfolio.
The compelling conclusion is that the baby boom generation will seek new "income and growth" solutions, not those old fashioned growth-and-income portfolios populated by "growth" stocks and bonds. Changing and volatile markets will also diminish the popularity of broad asset class allocations; they do not deliver what the boomers need, a significant and growing portfolio income stream.
There are currently very few high-powered options for boomer investors; dividend-growth equities are one. With 78 million boomers moving into retirement and pre-retirement mode, we expect that such dividend-growth common stocks will experience significant increases in demand. Next time we'll discuss this "Coming Wave."
Part I: Boomer investors will change everything
Part II: Waves, wakes and winds of change
Part III: From "pure growth" to "safe growth"
