The standard recommendation for investing for retirement is a straightforward one: Invest 10% (or more!) of your annual income, preferably via a tax-deferred account such as a 401(k) plan with an employer match, and allocate those dollars to an age-appropriate mix of low-cost stock funds, bond funds, and cash, which is relatively easy to do via target-date funds. Do this for 25 or 30 years and the resulting nest egg will likely be large enough, along with Social Security benefits, to support your retirement income needs via a 4% withdrawal rate or whatever rate is deemed prudent at that point.
But there appears to be a growing number of investors who, from the very start, are focused on creating income-producing portfolios. That is, their primary goal is the ongoing acquisition of dividend-paying stocks, mutual funds, or exchange-traded funds. For such investors, the primary measure of success isn’t the total return or balance of their portfolios, it’s the size of the income stream that these dividend-paying assets produce.
Why It’s Appealing
One obvious appeal of this approach is that the growing income stream isn’t a hypothetical one, based on an unknown withdrawal rate that will commence decades from now, from an unknown future portfolio balance. Instead, monthly or quarterly dividends are deposited in your brokerage account, which feels “real” in a way that a calculated future withdrawal rate doesn’t. Such income-focused investors can immediately compare their annual investment income with their living expenses, seeing which ones they can already cover from it—a cellphone bill, a car payment, and so on—and then calculate how much more income they’ll need to achieve financial independence.
Focusing primarily on your portfolio’s income stream can also make market volatility seem less scary. When the US equity market plummeted following the April 2 tariff announcements, anyone doing the math for a “4% of my 401(k) balance” annual withdrawal rate immediately felt the pain, as a 12% drop in their portfolio balance also meant a 12% decrease in the dollars they’d receive via a 4% withdrawal rate. Whereas the income-focused crowd could point to their seemingly unchanged income streams and feel less worried, even if their portfolio balances had declined by similar percentages.
Finally—and I can only point to anecdotal evidence of this—there may be a virtuous circle element to this approach. That is, it appears that some income-focused investors are investing at higher rates than they otherwise would, as their current income streams inspire them to purchase additional shares to increase that income stream. If you go to X.com or certain subreddits and search for the ticker symbols of some of the more-popular dividend ETFs, you’ll likely see scores of posts and comments from investors touting the number of additional shares they’ve added to their accounts that day.
This isn’t proof of anything, of course, and it’s limited to the subset of investors who post about such things online. But I have yet to see similar public announcements from investors touting the additional shares they’ve purchased for a target-date mutual fund.
So What’s the Downside?
I’m a fan of dividend-based investment strategies (after all, I edit Morningstar’s DividendInvestor newsletter!), but the downside of focusing exclusively on dividends is that they’re only one part of the total return equation, and chasing yield can result in some less-than-ideal security selection decisions. Giving up a portion of your portfolio’s potential total return in exchange for higher current income may be a reasonable trade-off for some investors, but it should be an informed decision. I’ll discuss some of the drawbacks of the “income first” strategy in an upcoming sequel to this article.