This is how one Fool is planning to beat annuity rates when he retires.
Billionaire investor Warren Buffett is well known for his focus on companies with strong earnings that pay good dividends. At the same time, he doesn't care much about share prices -- except when he's buying.
Buffett's investment style is as far as away as you can get from the aggressive, heavy trading approach pioneered by hedge funds -- but his returns are far more consistent and much easier for investors like you and I to replicate.
Here's the secret.
Buffet's 50% yield
One of Buffett's most famous long-term holdings is his 8.9% stake in The Coca-Cola Company (NYSE: KO). The $15bn shareholding is Buffett's company Berkshire Hathaway's largest holding and most of it dates back to 1988, when Berkshire spent $1bn to acquire a 6.2% stake at an approximate cost, adjusted for splits and dividends, of $3.75 per share.
Back in 1988, Coke shares offered a yield of 4% -- decent, but not amazing. Since then, the company has maintained its 50-year unbroken record of annual dividend increases. The result is that in 2011, the dividend payout was $1.88, providing Buffett with a massive 50% yield on his original investment.
Yield on cost
Despite its golden record of annual dividend increases, Coca-Cola is not necessarily thought of as a high-yielding stock: at current prices, it only yields around 3.1%.
This 50% is Buffett's 'yield on cost' -- the dividend yield on the price he originally paid. This is one the key benefits of holding shares in big companies over long periods, as I'll demonstrate below.
By simply maintaining his holding in a good quality company, Buffett has seen the yield on his shares rise continuously to provide an amazing 50% annual return on his original investment.
A British Coca-Cola?
Over the last 6 years, Buffett has spent more than £1bn building up a 5.1% stake in one of Britain's best-known brands -- a company with a 28-year unbroken record of dividend increases.
I'm pretty sure he likes this company for just the same reasons he liked Coca-Cola all those years ago -- and you can find out the name of the company and the price he paid in this free report.
You can do it too
The good news is that you don't have to wait 24 years to see big yield on cost increases in your portfolio.
In the table below, I've taken a look at nine popular FTSE 100 shares to see what their yield on cost would be today if you'd bought them just ten years ago, in May 2002. I think that the results speak for themselves:
|British American Tobacco (LSE: BATS)||793p||1.4%||15%|
|SSE (LSE: SSE)||679p||4.8%||11%|
|Vodafone (LSE: VOD)||118p||1.3%||7.5%|
|Tesco (LSE: TSCO)||246p||2.5%||6.0%|
|Unilever (LSE: ULVR)||1,396p||1.5%||5.6%|
|BAE Systems (LSE: BAE)||* 371p||2.5%||5.1%|
|Diageo (LSE: DGE)||856p||2.8%||4.7%|
|GlaxoSmithKline (LSE: GSK)||* 1,477p||2.7%||4.7%|
|HSBC (LSE: HSBA)||* 830p||4.0%||3.1%|
Source: Morningstar, company websites
* These share prices are currently lower than they were in 2002. Despite this, in 2/3 cases they still offer a yield on cost that is better than it was ten years ago. What's more, a Foolish investor would have used the falling share price as an opportunity to buy more and average down, thus improving their yield on cost still further.
Standout performer British American Tobacco has become a truly outstanding income share, thanks to a combination of share price growth and dividend increases. In second place is one of the most popular utilities with private investors, SSE, which also has an impressive record on the dividend front.
According to the Annuity Best Buy Table in today's Financial Times, a male aged 65 with a £100,000 lump sum can get a level annuity income (i.e. not inflation-linked) of £5,971 -- effectively a 5.9% yield on your capital sum.
Throw in a 3% annual rise to protect you from inflation, and that drops to £4,131 -- or 4.1%. Remember, this is for an annuity, so you lose your lump sum in return for your annual income.
Compared to this, I reckon our high yield on cost dividend portfolio is far superior:
- 6.97% yield
- You keep your capital
- If your shares are in an ISA, you won't pay income tax on the dividends
- Over time, your dividends will tend to stay ahead of inflation
Of course, a portfolio like this is riskier than an annuity, as some of the companies in it could go through troubled times -- think about Lloyds Banking Group (LSE: LLOY) and Royal Bank of Scotland (LSE: RBS), for example.
However, the longer you hold your shares, the more your yield on cost will improve, reducing the impact if one company goes pear-shaped.
Keep it simple
The best part of this approach is that assembling a high-yielding portfolio that will show yield on cost improvements over the next couple of decades is really simple.
All you need to do is choose a diversified mixture of big cap shares from different sectors (I'd stick to the FTSE 100), stick them in an ISA or SIPP and wait. Many FTSE 100 companies look excellent value at the moment and there really is no time like the present.
Finally, don't forget to check out that free report I mentioned about Warren Buffett's favourite UK share. I found it really useful and I think you might still be able to get it at the same price he paid, so it's definitely worth a look.
Searching for dependable FTSE dividend shares? This free Motley Fool report -- "8 Shares Held By Britain's Super Investor" -- reveals the major companies favoured by high-yield legend Neil Woodford.
Further investment opportunities:
Roland owns shares in Vodafone, Tesco, Unilever, BAE Systems, GlaxoSmithKline and HSBC. He does not own any of the other shares mentioned in this article.