Looking Ahead A Few Years Can Deter The Temptation To Do Something Stupid

If you do enough financial reading, you will eventually encounter finance writers that encourage you to buy companies yielding 7%, 8%, 9% as a suitable investment for retirees seeking income. With the exception of some energy MLPs (which can make sustainable high-yield distributions because they return all of their profits to shareholders and part of the payout is a return of your own investment capital), I find it unfortunate that certain companies are being touted as long-term investments when they don’t even have a five-year track record of making consistent payouts. Something yielding 10% now, but didn’t exist as a business in 2005 and cut its dividend in 2008 and 2010 doesn’t strike me as fertile soil for a long-term investment.

Yet, companies that have been maintaining high yields for a few years in a row often become competitive with many traditional blue-chip stocks, with investors saying things like “even with a 50% cut, this company will still yield more than most blue chips in the 2-3% yield range.”

I think a lot of pain that comes with seeing capital erode and seeing dividends cut (if you have owned something like Seadrill or American Realty) can be avoided if you keep the perspective of what your income will be several years after the fact from something that has a much lower initial dividend yield but is incredibly safe and comes with a high growth.

Take something like Chevron. It doesn’t get a lot of love because the dividend yield is usually in the 3-4% range, and this is below what people looking for high income desire. What catches my interest is this: the dividend payment has grown from $2.53 in 2007 to $4.28 by the end of 2014. With dividends reinvested, you picked up .218 new shares of Chevron by the end of 2014 for every share purchased in 2007.

When you look at something like Chevron and only see the 3-4% starting dividend yield, it can easy to overlook what that will become five, six, seven years down the line. Someone who paid $75 per share for Chevron stock in 2007 would be earning $4.28 entering 2015 on those shares, for an annual yield of 5.7% from one of the safest, multigenerational holdings in the world. With dividends reinvested, you see every 100 shares turn into 121.8 shares so that you’d be collecting 6.94% annually on your investment. With the 2015 increase and another year of reinvestments under way, you’ll be collecting over 7% from those Chevron shares purchased in 2007. You can sidestep the misery of dealing with dividend cuts from those stocks that initially yield 7-8% by thinking instead “Chevron + 7 years of dividend reinvestment” is a high-yielding stock in its own right. Adopting the approach of looking a few years ahead can be a helpful thing to keep at the back of your mind anytime you’re tempted to buy something offering a higher current yield but clearly lower quality.