How To Retire With A Millionaire’s Income Stream

Co-produced with Treading Softly.

Have you ever heard the saying “A million just ain’t what it used to be!”?

Inflation has a way of eroding the value of a dollar over time. I like to see unusual measuring sticks that help prove this point while also presenting a unique point of view. One such measurement is the price increase of a Big Mac from McDonald’s (MCD).

From 2000 until 2022, the price of a Big Mac on average in the U.S. has moved from $4.21 to $5.94. That’s an increase of 41% over the 22 years.

This means the value of your dollar has rapidly dropped in the face of daily costs.

$1 million in stored value just ain’t what it used to be. Yet it is becoming easier than ever to achieve an income equal to a millionaire. A $1 million account would generate $40,000 annually using the ultra-popular 4% withdrawal rule.

However, I find that income goals are abundantly more useful than dollar-value goals. If you’re invested in the market, your portfolio value will go up and down like a toddler jumping on a trampoline making it impossible to determine when you’ve really reached your goal. Furthermore, income is what you’ll be spending to cover expenses. You don’t need a lump sum to pay your electric bill for the rest of your life. You need money coming in to pay the bill every month for an unknown amount of time. You need income, so set your goals based on what you need.

That makes sense, right? I think so, and so do over 6100 members of High Dividend Opportunities.

Let’s look at two picks that generate a combined average yield of 10%, meaning you’d need less than $400,000 today to generate $40,000 annually.

Pick #1: AT&T – Yield 5.7%

Have you ever had that friend that is overly dramatic about the little things? Every little problem that comes about, they instantly turn that ant hill into a mountain.

Oh no! The milk spilled! It’s the end of the world!

The market makes that friend look like they have a cool head. Exhibit A: AT&T Inc. (T).

Six months ago, AT&T reported earnings, and the price crashed 10% almost immediately, there were a lot of positive things in the report. Revenues were up more than expected, it was a very strong quarter for subscriber growth, and T had made progress on paying down debt as promised. Yet there was some spilled milk: FCF (Free cash flow) came in lower than expected, and management cut guidance from $16 billion to $14 billion. Suddenly folks were proclaiming that T might cut its dividend.

We didn’t panic. We recognized that T’s reduction in its FCF target was primarily due to inflation and timing issues. We wrote:

At the end of the day, the telecom business has very reliable cash flows, even through recessions. AT&T’s FCF will be slightly lower than initially guided for this year, but it is still very high and easily covers the dividend. Business is growing, revenues are up, and their subscriber base is growing faster than expected, and that will eventually translate into higher FCF. We view the downgrade in guidance as being due to temporary factors that will work out in time, and therefore, the recent dip is an opportunity to add.

T’s price continued to fall in Q3 with the rest of the market and then rebounded strongly at Q3 earnings, and it has generally been going up ever since. Q4 earnings solidified that trend and provided another boost. In six months, T’s share price traveled from $20 down to slightly below $15 and back up to $20. What changed? Nothing. There was some spilled milk, the market threw a fit over it, and the adults didn’t panic.

For 2022, FCF came in at $14.1 billion, and guidance for 2023 is $16+ billion. AT&T continues to add subscribers at a steady pace. Source.

T’s guidance for 2023 is something we would describe as “modest” growth.

Mid-single-digit growth in revenue, 3% growth in EBITDA, and FCF back up to that $16 billion/year pace as the issues from last year fade into the past.

The past several years have been very difficult for T. Primarily because the conglomerate had become extremely complex that the core business suffered. That is what spurred T to spend its time spinning off DirecTV and Time Warner. AT&T Inc. was doing many things, but not doing any one thing well.

The reason for all the transactions T has done over the past few years was to simplify the business model and focus on the core businesses of phones and fiber. A very large, very mature business that is characterized by significant cash flow, high barriers to entry, and moderate but consistent growth.

T is doing what they said they will do. We expect them to continue chopping down their debt and get leverage down to 2.5x EBITDA, which management guidance calls for reaching in 2025. Once that point is reached, we expect the dividend will be increased as T will be comfortable paying out a larger portion of FCF. The current payout is about 50%, so for 2023/2024, we might see token dividend increases. At the minimum, we can expect the dividend to be maintained.

T has gone back to its roots as a nice and boring telecom throwing off large amounts of cash flow. We expect it will also return to its roots of raising the dividend regularly, especially once it gets leverage down to its target in 2025.

Pick #2: OXLC – Yield 15%

Oxford Lane Capital (OXLC) reported Q4 earnings on January 27th and continues to have a very well-covered distribution, not something you typically see with a 14%+ yield.

OXLC covered its dividend on a GAAP basis by 115% and on a core NII basis by 137%. Source.

OXLC continues to reinvest and raise new capital to invest in CLOs – increasing its portfolio by $32.7 million.

This is a slower pace than we saw earlier in the year. Year-over-year, OXLC increased its CLO equity portfolio at cost by 36%.

If there is a “weak point” in OXLC’s report, it is that NAV continued to edge down to $4.63/share. Note that NAV is primarily influenced by the fair value of CLO equity. CLO equity is illiquid, and only $100 million was traded in December. With a lack of trades, the value of equity positions did not climb in concert with rising loan prices. Although over time, we can expect the two to be strongly correlated. In fact, OXLC estimates NAV rose to $5.02-$5.12 by the end of January. That is an 8-10% increase in just one month.

Simply put, buyers of CLO equity pulled back at the end of the year. A lack of demand causes prices to decline. It is important to remember that OXLC’s investment plan has never been to sell CLO equity at a higher price. OXLC’s primary strategy is to buy and hold until maturity. OXLC’s returns are not a function of how popular CLO equity is and how much others are willing to pay for it. OXLC’s returns are dependent upon how many borrowers will pay off their loans.

CLOs continue to experience historically low levels of defaults, with only 11 loans defaulting in 2022 for a default rate of 0.68%.

The price movements in debt have much more to do with the Federal Reserve and rising interest rates than it has to do with concern over repayment. OXLC is paying out an enormous dividend today and will see a significant upside if default rates remain low.

Conclusion

Want to retire with a millionaire’s income stream? Generate over $40,000 in annual dividends. I recommend you reinvest at least 25% of your incoming dividend income, so if you’re applying that principle, you’ll want around $54,000 in dividends so that you can keep $40,000.

With T and OXLC, we have two vastly different investments that together can help propel us towards having that millionaire’s income stream. This is how we balance our portfolios, some lower-yielding picks that we expect to grow their dividends and some super high-yielders that provide an attractive risk/reward. We seek to achieve a blended yield of 8-10%.

Furthermore, no investment portfolio is complete with only two holdings. We recommend holding no less than 42 individual investments when crafting a portfolio to rely on for long-term income. This way, no one investment’s change in value will “sink the ship.”

So many of us set the goal to reach $1 million in retirement, but so few consider how much income that really generates using traditional withdrawal techniques.

With inflation eroding the value of stored cash, making it less powerful year after year, I strongly recommend you set an income goal and ensure your income continues to climb annually via reinvestment.

That way, you never run out, and you never fall behind. That’s the beauty of income investing.