This article originally appeared on Seeking Alpha and you can find it here. Leave a comment below or check out the conversation that followed at Seeking Alpha. Some very good advice was shared as well as other investors experiences with dividend investing.
Most of us are working towards financial independence, typically referred to as retirement, but the timeline for achieving such a feat is open for debate. Once your accumulated assets are enough to support a safe withdrawal rate of 3-4% and your expenses are covered, you can declare yourself free from paid work. Sounds simple right? Putting the plan into practice is the challenge for us all. In this article I want to share with you some of the reasons I’ve adopted the dividend investing strategy as a means of attaining financial independence and hopefully doing so just a little earlier than usual.
It’s only fair to tell you that my investing experience is limited to just over a year. The first stock purchase for my portfolio was made in December of 2010 with one paying no dividend at all and the other a very negligible one. I continued to read, observe the markets, and educate myself as much as possible. In early 2011 I was exposed to dividend investing and began reading everything I could get my hands on. Books, articles, blogs, you name it. I was intrigued. It wasn’t long after this initial exposure that I found Seeking Alpha and the wonderful contributions from both writers and readers. The more I learned the more I realised that dividend investing was going to be a large part of my investment strategy. The following are a few of the reasons I find it so appealing.
I. Narrowing The Field
Deciding which stocks to invest in can be a daunting task to newbie investors like myself, actually it’s down right intimidating and I can see why many people decide they are not up for the task and leave it to the professionals or worse avoid it altogether. Choosing to buy dividend paying stocks with acceptable yields narrows this very broad field down to a more manageable one. Having a list like the Dividend Champions is invaluable when you are just starting out. It makes the entire experience of investing a little less scary. You guys/gals who have been doing this for decades probably don’t remember what it is like to be starting out. Those of us new to the game like to stay close to shore while we are learning to swim and dividend stocks allow us to do just that.
II. Easy to Understand Selection Criteria
This is closely related to number one. Once you have narrowed your potential stock selections down to a list of highly regarded candidates it’s time to actually make a decision on which ones to add to the portfolio. This can be a paralyzing time for a new investor; after all how do you know if you’re selecting the best stocks to reach your goals? Again, dividend investing makes this process just a little bit easier to understand. I’m not the most sophisticated stock selector out there and many times I have doubted my abilities. However, when you are looking at dividend stocks the selection criteria is more straightforward. Evaluating indicators such as yield, dividend growth rate, payout ratio, and debt load are indicators that are easier to understand when making that final decision to buy. I remember having a discussion with a friend when I first started building my portfolio and I told him this was the main reason I was taking the dividend growth approach; I had a better understanding of the selection process than I did for other classes of stocks.
III. Dividends Are Tangible
Over the past year, as I’ve attempted to become an enlightened investor, I’ve read countless books including Graham, Fisher, and Loeb. I’ve watched the markets almost daily and how political news, economic reports, and natural disasters impact market behavior. Forum discussions, blog posts and articles by financial experts have caused me to draw one conclusion: that we often confuse theory and practicality. What I mean by this is that too often I hear people discredit dividend investing because it is inferior to growth investing or that the dividend investor is really not getting anything from dividends that he/she did not already own. There are other opposing arguments and I’m sure you have heard them as well so I will refrain from covering all of them.
I make a distinction between theory and practicality. Avoiding this distinction is the source of a great deal of confusion for everyone. I know this because when I’m reading these articles against dividend investing I’m left questioning whether I’m indeed losing out on a greater return and I’m sure if you are honest no matter if you are a new dividend investor or an older one contemplating monetizing your portfolio through dividend stocks, you have experienced the same doubts.
If you put the debates about theory aside and ask the dividend investor what he/she wants guess what the answer will be? INCOME! Income from assets that are reasonably secured from long-term capital loss. Whether you are a young guy like me looking to gain the flexibility that financial independence provides or a retiree looking to enjoy the autumn years of your life, you find that dividend investing can provide for both without having to sell off assets. That last point is critical and I want to address it a little more thoroughly.
When I first started studying the markets and retirement planning I was surprised by the two main approaches: income from assets versus selling of assets for income. In the first case you build up enough assets in which the income generated will cover your expenses. The second approach you go through the same accumulation phase, but then you sell assets to generate income to cover expenses. Now I’m no guru, but I tend to think it is a bad idea to sell assets to generate income regardless if we are talking about Your Family Inc. or Ford. It is a preference of mine that during bad years I do not want to be in a position in which I’m forced to sell assets at discounted prices to cover expenses. This is the scenario an investor will find themselves in if their only source of income is selling the assets they have accumulated. True, there are risks in following either approach, but relying on income provided by dividends seems to be the better method for mitigating that risk and weathering any down year(s) in the market. Bottom line: dividends pay the bills.
IV. Emotional Stability
This is probably the most important factor of all. There are numerous studies showing that many investors don’t get the market return in any give year. The reasons for this are numerous and involve high fees, tax inefficiency, commissions, and buying high/selling low. The last one is the one I want to concentrate on.
Last year was my fist year in the market. I remember the beginning of the year being all smiles and giggles. Literally everyday the value of my portfolio was going up. I remember thinking, “Why didn’t I start this years ago? At this rate I’ll be wealthy in no time!” Then in July the party was rudely interrupted and for the remainder of the year things got a little hairy. I was now thinking, “At this rate I wont have any money left!” It seemed as if I was earning a graduate degree in the lessons of volatility. I don’t know if the level of volatility experienced in the last half of 2011 is the norm, you guys and gals who have been doing this longer than I have please chime in, but for a newbie investor like me this was a white knuckle ride! Gone were the gains from earlier in the year. Gone was the value of some of the capital I had invested, but I stayed the course and kept buying at the same time I was watching the markets make 300-400 point swings in a day! I truly belive the only reason I was able to continue to buy was that I knew I was getting better yields and even though the market value of my holdings were taking a beating, my income stream via dividends was stable and even better, it was growing. I think this is what they mean by the saying, “Pick an investment strategy that allows you to sleep at night.”
When it comes right down to it investors need clear and long-term goals about what they are wanting to achieve. This will determine the investment strategy that will work best in the attainment of those goals. Regardless if you are a younger investor attempting to achieve financial independence or are just planning for traditional retirement, I think dividend investing is a solid strategy to utilize.
I’d love to hear how you came to dividend investing. Was it your original plan or did you come to it after trying other methods?
The Stoic Investor 
Hi, so it sounds like you are for dividend investing because of the immediate return of income? And it sounds like you understand that if you invest 10k in a non-dividend paying fund, and 10k in a dividend paying fund(re-investing dividends) you should theoretically and will in reality have the same amount of money over a long period of time(20+ years).
Personally, I think they are a good idea for older investors for the reasons you stated. I don’t think they do much for younger investors though. I would rather invest in a total market fund that will diversify across non-dividend paying funds and dividend-paying funds. What do you think?
Thanks for stopping by! I do favor dividend investing for the income stream that can be built independent of selling the assets behind that income. I believe that it really comes down to what an investor is hoping to do with his investments. Theoretically the two funds you mention might end up, in the long run, having the same value. The risk I think you can reduce with income from dividends is the risk of what happens in the event a market crash wipes out half of the market value of your account? You may end up in a situation where you are selling assest at lower cost than you paid for them to cover your expenses.
There is certainly nothing wrong with index investing. If you don’t want the hassle of researching individual stocks than as you say a dividend oriented index fund would work. I don’t think there is a right or wrong answer here, just a difference in means of attining the same end.
Hope I answered your question, but if not please let me know. Have a great day!
If the market crashes, then you will be right! But if the market goes up, you will miss out on the capital appreciation since you are not re-investing your dividends 🙂
I like index investing as opposed to dividend investing because it diversifies against both scenarios. But you can really argue either way, so nice work on a very informative article.
Oops…. I mislead you. I invest for the income, but I’m not taking any of that income out of the account. It rolls over into purchasing additional shares.
It is often assumed that if you are a dividend investor you are giving up capital appreciation. You still get the capital appreciation, granted it may not be as high as what you would see in a pure growth portfolio. Most of my holding have experienced moderate growth at the same time they provided income. I hope over the decades to come they do the same.
Thank you for the compliment. I wish you the best with your investing goals.
Well, you know what I think about dividend growth investing!
I think there are many ways to skin a cat, but I truly believe dividend growth investing is one of the best ways for an individual investor to build wealth over time. Sure, you can pick stocks that will shoot up 100-200% in a year and blow away measly 3% dividends, but you can, and will, also pick stocks that will wipe you out.
I like slow, steady and sure.
DM— Ha Ha… Yes I do know where you stand and you have done a great job at skinning your cat! 🙂
Dividend investment is great when it comes to beating inflation. but its bit risky and you need to do a bit of homework. I prefer it but would hold my position for a long term investment
I agree with you, it does require some work. Fortunately, I enjoy doing the research and have time to do it. Thanks for stopping by!
Hi Stoic Investor,
I have included this post at my website weekly roundup #2
http://www.chase-a-dream.com/weekly_roundup_2.html
Thank you! Much appreciated.
My problem is by picking a handful of stocks you are taking on too much risk by not being diversified enough. Sure, when you swing for the fence, sometimes you get it all, but sometimes you strikeout. I’m not convinced anyone has ever consistently applied their analysis in picking a handful of stocks and returned excess over what the market indices have, over the long-term. Why not pick a mutual fund or ETF that focuses on equity income and let it ride? That way you are diversified a bit better.
Also, it should be pointed out that dividend investing in a taxable account usually isn’t the most tax efficient. There are worse options, like a REIT, but you have to pay tax on the dividend EVERY year, which erodes away your capital, especially over the long term.
Thanks for stopping by and contributing to the discussion. An investor does need to have a diversified portfolio to mitigate the risk of one stock wiping out the value of the portfolio. My portfolio at the moment is not diversified enough and over time I will add a few more positions to lessen the risk of any one stock impacting the value too much. How much diversification is needed is up for debate. For me I don’t need the diversificaton I would get in a MF or ETF, I don’t need to own the entire market. I really don’t see myself having over 15-20 stocks in my portfolio. I feel this will give me the diversification to reduce risk.
Continuing with your baseball example, I’m not looking for grand slams or even home runs nor am I looking to strikeout all the time. I’ll be happy with solid base hits over time. Dividend investing is not an attack against indexing. Both are a means, not the means of achieving one’s goals.
The tax issue is certainly a consideration with any investment plan, but it’s not the only factor I consider. The gov’t is going to get its share of your earning at some point in time. You can delay it by investing in tax sheltered accounts or you can pay it now. The portfolio I’m creating here is designed to eventually cover most if not all of my expenses. I also have other retirement accounts that also offer indexing and tax sheltering benefits. So as you can see I don’t have all my eggs in one basket.
Have a great weekend!
It’s true that you will have to pay tax, and I’m not suggesting evading one’s duty to do so. I’m talking about what is most tax efficient. You might want to do some calculations on how taking 15% (+ whatever other taxes you would have) out every year differs from growth (which is allowed to compound until cashing in).
I’m not disagreeing with you on the tax efficiency issue, it’s just not my only goal. I have other goals for this account. It may seem like a waste not to maximize the return a person could get on their invetments, but I still think that one has to answer the greater question, “What do you want to accomplish?” and then work the best they can to reach that goal with all the other questions being taken into consideration. I do have other investments in tax sheltered accounts so I hope I’m getting the best of both worlds.
Now, if the 15% tax rate changes like many people believe it will I may adjust my strategy, but doubt I will completely abandon it.
You have raised good counter arguments to my strategy which I think is great because it increases all of our understanding of an issue. Thank you.
Outstanding post. The notion of selling a portion of a portfolio to support retirement never made sense to me either.
My first investment was in a little company called Intel, purchased when I was in 10th grade on advise from my dad (this was the mid 90’s). Little did I know the sucker was going to be a 10 bagger. Of course I ended up selling it and blowing through the money as most college kids would do. To make the story short I lost my shorts in the tech bubble (didn’t have much money, but learned valuable lessons), then turned to mutual funds. Fast forward to 2010 and I’m left wondering why the mutual funds didn’t perform the way they were supposed to, the way I read about. Not happy with index funds I started researching other ways to invest and found dividend growth / income investing. It resonates with me and fits my temperment. It’s the kind of thing my grandpa might have done. I like that. I bought my first dividend growth stock August 2010 and think I found something special.
Other strategies work as well.
Fun fact: I once again own Intel! This time as a mature company that is a dividend machine instead of a growth machine.
CI– Thank you for the compliment and sharing your experience with DGI. I always enjoy hearing other investor stories regardless of what their investing method is.
Have a great day!
Good article and great reasons to favor dividend stocks. Income is the one that resonates with me the most. An argument against growth stocks is simple: how do we know which growth story will play out the way we planned? It is easy for a company to get off track. A good stock will survive and likely flourish despite short-term issues, market swings or management missteps. Should such scenario materialized dividends will keep the investor afloat.
I managed a small portfolio of 400k-500k before the crash and watched it diminish in value by the day. It took years to recover (I have not sold a single stock). Yet through those years I received 5% in dividends per year, which over 3 years of “wait time” amounted to a nice 15% return just for waiting. Yet another reason to love dividends! Covered calls also helped, but that’s another story in itself.
AverageCFA– Your example of predicting a growth story is a big reason I stick with divi stocks. I’ll be the first to admit I’m not able to value a growth stock and at this point I’m not even going to try. I’ll continue to improve with the DGI for now.
Thanks for stopping by!
Great article! This is the first year I have purchased individual stocks to start building my dividend portfolio. Although I plan to max out my tax-deferred options first like my 401k and Roth IRA, I believe that a dividend income will make a nice compliment with the low 15% taxes.
Thank you. I’m beginning to do the same thing now. Utilizing the retirement accounts and using the rest to build up a dividend portfolio. Lets hope the 15% tax rate stays that way.
Great stuff man. Love your story. I’m proud of a complete stranger!
Thanks Johnny!!