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You Are Going To Have Too Much Money

Dividend growth investors sure feel like they have it all worked out. While volatile, roiling, go-nowhere markets leave most investors feeling like spawning salmon trying to swim upstream, the dividend growth crowd seems to be coasting along, riding their inflatable rubber duckies as they sip pina coladas, trailing their toes absentmindedly in the water as their portfolio income climbs ever higher.

But dark clouds rumble and churn on the dividend growth investor’s horizon.

While ignoring your portfolio is heavenly bliss, it is, alas, like all good things in life. It too must inevitably come to an end. If you are a dividend growth investor, there is a simmering problem just waiting to boil over, feeding on itself at a geometric rate. Eventually (and probably when you are not paying any attention) you are going to start earning too much money.

You know you must be living right when you can proclaim that earning too much passive income is something you need to worry about. On some level, that sounds like EXACTLY the sort of problem that I'd be delighted to live with. Even once you've convinced me to actually take that problem seriously, it’s a problem that will never compete effectively against other problems in life that hold my current attention. I'm usually not a procrastinator when it comes to tackling financial problems, but somehow, this problem is different from the rest. The problem of earning too much money is the proverbial can to be kicked down (or to the side of) the road. Maybe worry about it (or not) once it's a bit less hypothetical.

On the other hand, I know that money problems are no different from any other problems in life. Which is to say, it's always those hypothetical problems that seem to have a way of becoming extremely non-hypothetical and by the time they do, you're usually fresh out of options for dealing with them.

An illustrative hypothetical. Suppose yours and your husband's living expenses are $100,000 a year, you live entirely off portfolio income and your portfolio is generating $100,000 in qualified dividends this year. Life. Is. Sweet. You can ignore your portfolio's price. You are a zombie investor. You never need to sell anything, so obviously you don’t. You pay zero Federal income taxes (you can shield the first $24,000 of income with the standard deduction, and the first $78,750 of qualified dividend income carries a marginal income tax rate of 0% for 2019).

But now let's suppose that your portfolio dividends grow by 10% a year next year. And the next, and the next. In about seven years, you're pulling in twice the dividend income you need, and what's more, it's costing you. Your tax bill is going to go up from $0 to about $14,498 (and that's assuming tax rates stay constant). To some people, that's a worthwhile cost for $200,000 in qualified dividends but to other people, it’s like buying a useless $14,498 widget that's just going to end up stuffed in a drawer somewhere. And on a more fundamental level, does striving for more and more of what you don’t need make you any happier? I can’t speak for you, but I’ll tell you what I’ve noticed. I seem to feel happy and free when I forego consuming stuff that I don’t need, but anxious and unsettled when I pine for larger, fancier, faster and better, and the means to buy it without breaking a sweat. "More" is simply not the answer for everyone - especially when it's in the form of "more" income taxes on income I don't need or want.

Suppose you get to the point where you don't want more than enough. Here is a simple enough solution: trim your portfolio income by selling some of the capital that’s responsible for generating it. You can’t make the companies you invest in stop raising their dividends, but you can accomplish the same thing by just unloading some shares. The bad news for you is that the price for those shares may have risen in tandem with your dividend income. Which means you, my friend, can't sell without getting the capital gains tax equivalent of a bucket of ice water dumped on your head.

Dividend growth investors might enjoy thinking they're on the right track, but they aren't alone on that track. You see off in the distance that there's a slow-moving, 100,000 ton freight train called "compounding" coming your way... and it's accelerating the closer it gets. If you spend less than your portfolio earns and you own companies that raise their dividends seriatim, you face a very real risk that one day, you are going to be earning too much money (which may or may not bother you). Even if your portfolio does not yet generate enough dividend income for you to live on, why not check your portfolio’s past income growth rate and your past savings rate, extrapolate from there and see how much longer till you hit the crossover point? But don't make the mistake of stopping your simulation there. The power of compounding sure won’t.

At least, not on its own. You need to intervene if you want to keep this thing from snowballing. But when? Do you sell a little capital now to keep your future income growth trajectory manageable? You could put the proceeds into non-income producing assets. You could just hold the cash. You could do what your financial advisor and personal finance gurus are telling you to never do: spend some! I’m not saying you should pig out imprudently. You want to be more like that jealous type who sees the neighbor pull into the driveway with a new Mercedes, and who then takes that as an invitation to go over and ask to "borrow" a few little things with no intention of reciprocating. You want to schnorr, rather than sheer, your portfolio (any Yiddish speakers, feel free to chime in).

As your portfolio income grows, you pare back income-producing assets. Take that earlier example. Suppose a year goes by, and your portfolio income grows to $110,00 a year and you only need to spend $103,000 to keep up with inflation. Your portfolio will be generating $7,000 more dividend income than you need, and you know that number is only going to grow as long as the companies you own keep raising dividends. If your portfolio yields 4%, that $7,000 of excess income translates to $175,000 of capital that you could potentially convert into something like cash if you wanted to hold your income growth in check. In fact, it could even be a little bit of a hedge. What if a financial crisis hits at some point in the future, and the companies you own slash their dividends? You could sop up any dividend shortfall in your portfolio with some of that $175,000 in cash, or maybe even boost your portfolio income back up again by purchasing some more shares (probably at bargain basement prices, too, since that’s what happens during a global financial pandemic).

But why wait? Suppose your portfolio generates $90,909 a year and if you are reasonably confident that the dividend growth rate will come in at 10% on average. You might be able to afford to retire a year early if you happen to have an extra $9,090 of cash to make up the shortfall until your portfolio income “grows into” your projected $100,000 spending. Or two years ahead of schedule if you’ve got $26,445.5 in cash to draw down while your portfolio “grows into” your projected spending. You get the idea.

Or maybe you want to start pruning some of your dividend producing stocks now, even though the portfolio income isn't quite at your $100,000 crossover point, because you know it'll get there eventually. And then keep going.

It's hard enough, working and saving and investing so that you can build a portfolio that churns out enough dividends to cover your living expenses, that you may not think much about what comes the day after you hit that goal. But dividend growth is unrelenting, which means you are probably financially better off than you thought. And no matter what stage you’re at in building your portfolio, maybe it’s not too soon to contemplate the risk of becoming too better off in the future.

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