At its core, a stock represents part ownership in a company. You are literally an owner of a real business, and as an owner, you deserve to get paid. You shouldn’t hope that the company does well. You shouldn’t hope that stock prices increase. Hope is not a strategy! If you are an owner, you need to be getting paid.
I’d like to give you a word of caution: dividend payments are optional. A company is not legally obligated to pay a dividend, so if the business runs into difficult times, the dividend might be cut or eliminated completely. Companies don’t like to cut dividends because it often spells doom and gloom for their stock price, but it does happen. That’s why just finding dividend-paying stocks isn’t enough. You need to find companies that not only pay a dividend but those that have been paying (and increasing) dividends for years.
You Can’t Fake Cash
When investing in stocks, you really need to treat it as if you are a real owner of the business, because you are! While I don’t expect you to be an accounting wizard, you should at least understand this: you cannot fake cash. Fancy accounting allows company management to make profits on the income statement bigger or smaller than they actually are. How quickly do you depreciate an asset? How do you value your inventory? These can be tweaked, but when a company sends you a check for your cut of the profits, it’s real. Because dividends are cold, hard cash, it makes sense that the underlying companies have conservative balance sheets.
Grow Your Money Faster Than Inflation
One of the biggest worries in retirement is that inflation will eat into your savings. The average annual inflation rate is 3%, so as long as your investments increase their dividends by at least this amount, you will beat inflation. For example, if companies manage to increase their dividends by 6% over the long-term, your income will grow faster than inflation. Is this feasible? Absolutely! Coca-Cola has been increasing dividends for over fifty years and has been increasing its dividend by over 8% per year for the last ten years. You’d be getting at least an 8% pay raise each year.
Who Cares About Stock Price?
Don’t get me wrong, I still have some money invested in index funds, ETFs, and growth stocks, but I sleep better invested in dividend stocks. Here’s the most important thing to remember about dividends:
You get your dividends regardless of what happens to the market price of your shares.
This was the game-changer for me. If I invested in Emerson Electric (which has been raising dividends for nearly sixty years), it could go from $55 to $70 to $45 and then to $50, but I wouldn’t lose any sleep. Not just because I’m investing for the long-term, but because I’m invested for a paycheck, not a sale price.
Typical investors freak out over stomach-churning market movements, but the dividends will continue to be paid as long as the underlying company makes money. Last time I checked, the dividend kings and aristocrats were making a ton of money.
In reality though, if companies continue to pay a growing stream of dividend income, do you think the stock price will fall? A growing dividend exerts upward pressure on a company’s stock price. Let’s say a company’s stock price is $100 and they currently paying $5 in dividends, or 5%. Let’s also assume that the company continues to increase the dividend, and after a few years, is finally paying $10 per share at the same stock price of $100. Other investors would look at the 10% dividend yield and probably trample each other running to buy some shares. All of the buying would push the stock price up to the point where the dividend is similar to other comparable investments.
Do I Spend The Income?
Whenever I tell people that I’m invested in dividend stocks, they tell me that those are “old people stocks”, meaning they should be used as a source of income in retirement. While this is true, I still choose to invest in dividend-paying stocks because I can reinvest the dividends and compound their growth. If you aren’t spending your earnings on bills and groceries, they’re available to be invested back into more dividend paying stocks. This makes your income stream compound on top of itself to create more and more wealth. I gladly reinvest my dividends.
I Dream About the Stock Market Falling in Value
If you’re a dividend investor, not only do you sleep better at night, but you actually crack a smile when the stock market falls. Sound crazy? Because your income is independent of stock price, you’re able to keep the checks coming in. When you re-invest at a high price, you aren’t able to increase your share count as much. Let’s continue with our $100 stock from above. Let’s assume you own 100 shares (worth $10,000) that pays you a 10% dividend (worth $1,000). If the stock price stays at $100, you can only buy ten shares. However, if the stock crashes down to $50, you can buy twenty shares, which will continue to pump out dividend income for you. The stock market could fall by 50% (like it’s done before) and you would multiply your initial investment more than 4X.
Everybody else will be upset about losing half of their money, and you will be laughing all the way to the bank.
What About Index Funds?
Because of dividends and reinvesting, I will blow the S&P out of the water over the long-term. Sure, I might underperform in the short-term, but does that bother me? Not one bit! I know that if I stay the course, I’ll get where I need to be. Besides, what is the goal of your portfolio anyway? Is it to beat an index? If an index fund returns 16% one year and you only get 15%, are you going to feel like a failure?
One of the biggest arguments for investing in index funds is diversification. If you own every stock available (you are “the market”), you won’t be crushed by a big drop in any one stock. This makes sense, but I prefer to own the best businesses. Besides, the highest-quality dividend stocks tend to fall less in bad markets. Because I’m investing in companies that consistently raise their dividends every year, I’m automatically picking some of the highest quality stocks available. There are thousands of different stocks you can purchase, but there’s approximately fifty that have increased their dividends for over twenty-five years. That’s the top 1% of all stocks.
I don’t want to mislead you about diversification. If you choose to invest in dividend stocks, you will be leaving out about 40% of all the public companies that do not pay a dividend, but you will have (arguably) higher quality companies.
What do you think? Do you like dividend stocks? What are your thoughts? Share in the comments below!