Look up! Thank Jesus for saving you and giving you every opportunity, including the ability to invest. I’m sure wherever you are now life isn’t easy but something must be working or you wouldn’t be here. That said, let’s talk dividends.

Well, as the title would imply, we’re going to cover every conceivable aspect of dividend investing. Good to bad and every thing in between, when we’re done here you should have an appropriate understanding of dividend investing and whether it may make sense in your own portfolio. As we progress, I’ll share a little of my own story but I’ll try not to wander to far off course.

Full disclosure – If you’ve viewed my Unqualified Portfolio, you may have noticed most of my holdings pay a dividend and that isn’t by mistake. I think dividends are a great way to stay focused and that psychological benefit, in my opinion, shouldn’t be ignored.

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Power of Dividend Investing

The power, if we wanted to call it that, really comes from the consistent passive income stream and the ability to compound that income over time. While companies can and do cut their dividends, picking a solid company with a sound plan could mean additional income forever.

If the idea of passive income is of interest then dividend investing may just be for you. Dividend stocks or ETF’s are simply those assets that pay out a portion of their profits to you and I, the shareholders, in the form of a cash payment. On the surface, the amount paid seems relatively small by comparison to the invested amount. However, account for time and that dividend is very likely to grow. Resulting in an even larger dividend payment.

Dividends may not seem exciting and virtually everyone on Reddit seems to favor growth stocks over dividend payers but the truth is those dividends can add up fast. The alternative for those favoring growth would be that during a recession, most assets aren’t growing but contracting. In a contractionary period dividend investors will have the added benefit of cash payments while the economy is in correction.

Ultimately, I think both sides of that argument have merit so there isn’t a one size fits all approach. That said, there is indeed power in dividends, especially as those dividends are re-invested so it’s fully worth consideration.

Passive Income

Exactly as it sounds, passive income is money earned without doing much, if any work. Easily the most notable facet of dividend investing is the ability to buy shares once and have that pay you at regular intervals. Many would argue that dividend assets should only really be utilized by those in retirement or nearing retirement but I’m not so sure. In either scenario, the investor is receiving a cash benefit and for the life of me I can’t understand why that’s a bad thing.

Regardless, passive income is generally considered a true path to wealth. Think Bill Gates or Jeff Bezos, or literally any other ultra wealthy human and I can assure you at this point, their money is earned passively. That may not have been true while they were building their respective businesses but by now they’ve handed over those keys and are just letting the paychecks roll in.

In the age of the internet, or now artificial intelligence, the plethora of ways we might earn a passive income is ever growing but also ever changing. As I write this today, a simple Google search will return thousands of posts or articles on the latest passive income ideas. For example, here is a post from Shopify.com, “29 Smart and Simple Passive Income Ideas for 2024”.

Compounded Returns

Really the key aspect to dividend investing is in the ability to re-invest additional capital. As I see it, it’s like having someone chip in a little extra cash each year to the amount we’re investing. Kind of like working for a company that has a retirement match benefit. Those that receive a match from their employer and invest in dividend paying assets are especially enjoying the compound effect.

Initially, the compound return seems small and psychologically doesn’t seem worth the effort. Although, after some time has passed you’ll really see the compound effect take shape. For those with an imagination, picture the day where your portfolio grows more in a year than you ever earned working a full time job. That sounds pretty awesome to me.

In any case, this is the reason we invest. We want our small pile of money to compound into a much larger pile. And while it isn’t necessary to receive a dividend to have your money compound over time, dividends are a passive way to continue investing without having to contribute additional capital.

Dividend Growth

Surely one of the primary reasons anyone would consider dividends would to one day have their assets pay them enough each period to live off of the income. The old school retirement rule is 4%, whereby we would extract 4% of our portfolio value each year for living expenses. Alternatively, dividend investors usually have dreams of never touching the principal investment and instead intend to collect their “pension” in the form of dividends.

Consider this, Coca-Cola is a well-respected dividend payer and has been for my entire life. Had I made an investment there 30 years ago, my dividend yield would stand today at a whopping 19.40%, according to Seeking Alpha. Imagine that, a near 20% return on my investment at every dividend payment date. But it’s the truth, as the company earns more they either increase the dividend payment or re-invest that excess into the company. Staple companies similar to Coca-Cola generally do both to even further benefit the shareholder.

It’s worth mentioning however, that those investing in individual companies are at a mild disadvantage in my opinion. As seasons change and new trends emerge a once stable company may begin to struggle. That struggle could lead to an unexpected dividend cut. Companies that cut their dividend essentially pull the rug out from under faithful investors. I’ve experienced that more than once which is why I’ve opted to focus my approach on ETF’s rather than individual companies. Although, if you’re up to the task of monitoring the company vitals then a larger dividend is more than achievable.

Defensive Characteristics

Not to be ignored are the defensive traits of dividend investing. First, dividend payers are generally established companies that have secured a firm financial footing in their industry. As mentioned, it doesn’t mean things won’t change but it is nice to know that our investment is made with an experienced company. Not the pump n’ dump wild west of meme stocks!

Additionally, as the market goes through a recessionary or contractionary period, dividend investors have the unique benefit of re-investing the additional capital at very favorable share prices. Typically, when the economy struggles, we as people in the economy, also struggle. Thus does our ability to save and invest. While we may not be able to commit the extra capital during that time we would be able to re-invest those dividends and secure even more shares at the rock bottom price.

Lastly here, dividend focused companies usually don’t experience the same level of price volatility. Primarily because of the dividend. During difficult economic periods it isn’t uncommon for investors to rotate large swaths of capital into these assets. Effectively keeping the share price higher than it otherwise would have been if this were a more volatile sector.

Quality over Quantity

Admittedly, this one took me several years to conclude. It’s honestly shocking to me how little attention this aspect is given among the investing community. However, hear it here, if you don’t already know. One share of a great company is better than 10,000 shares of a mediocre one. Sure, I understand the counter argument, that mediocre company may grow into a staple of the economy. My experience however is that mediocre company will eventually become irrelevant.

Also, don’t let the dividend yield of those subpar companies distract you. It isn’t uncommon for those companies to pay an above average dividend but that dividend is just that, a distraction from the company itself. Let me provide an example.

A few years back I stumbled on to B&G Foods (BGS). At first glance they seemed to fit all the criteria I was looking for. They were lower priced, so I could easily afford more shares. The dividend yield was around 9% and I had plans to sell covered calls to earn an even larger “dividend”. I decided to invest about $2,000 dollars to receive 100 shares of BGS but I also decided to buy 2 shares of Microsoft (MSFT) at the same time. I don’t think I need to tell you which one of those two investments actually made me any money. I went on to lose about $1,000 on BGS while Microsoft earned me about $400.

I hope my mistake will serve as the lesson. Quality over quantity. It’s important!

Dividend Re-Investment

For those still in their earning years of life dividend re-investment is vital to the growth of a dividend focused portfolio. Essentially, dividend re-investing is taking the dividend and buying more shares of the asset. This couldn’t be any easier for modern investors with most brokerage’s offering the ability to automatically re-invest the dividend amount. Even if the amount results in a small fraction of a share.

By utilizing this feature or by simply doing the “work” of re-investing the dividend each period the investor will maximize their ability to compound the investment return.

As a sidenote and more than worth the consideration, I seen many successful investors neglect to re-invest the dividend back into the company that paid the dividend. Instead, they’ve elected to re-invest the dividend back into whichever asset they’re holding that pays the next upcoming dividend. In this way, they are maximizing the next dividend payment they’ll receive. However, take note that this strategy may not always be the most advantageous, doing so may forgo buying shares of the original investment at a favorable price.

Dividend Kings, Champions, Aristocrats, Contenders, & Achievers

In order from best of the best to up and coming;

Each of these respective groups have increased their dividend each year for the number of years listed. Not an easy accomplishment given the financial turmoil we’ve all experienced over the years. Nevertheless, these lists could serve as a nice starting point for investigating an investment opportunity.

Caution! – I would not view these lists as the be all end all. They completely neglect index funds, ETF’s, bonds, etc. and are instead only focused on the companies themselves. An easy oversight, and one that I have also made.

Downside to Dividends

The argument against dividends is always growing but the complaint I hear the most is in regard to growth. By electing to invest in a dividend paying company we chosen to invest in a company that has already achieved most of its growth. Meaning, they’ve expanded into most areas of the world and have built their businesses to supply that product or service to those areas. While dividend payers can still grow, the growth is comparatively less than those companies that pay a smaller or no dividend at all.

Additionally, and we’ll discuss this next, are the tax implications of dividends. In an effort to avoid an extraneous tax bill I’ve housed most of my larger dividend payers inside my Roth IRA so uncle Sammy doesn’t get too large a cut.

Another argument I hear occasionally is with regard to diversification. The thought is that by eliminating investment opportunities to only those that pay dividends we effectively eliminate the thousands of other companies in existence that don’t pay a dividend. Truthfully, this one deserves some attention as every dividend paying company was once a non-dividend paying company. Should we completely neglect any asset that doesn’t pay a dividend today we may indeed be missing out on some worthwhile investments.

These downsides would collectively be referred to as opportunity cost or the cost of missing another opportunity. Therefore, it’s important that each investor conclude what their goals, risk tolerances, or portfolio makeup should be before ever beginning to invest. Not an easy task for sure but one that is essential and will reward you many times over.

Uncle Sam and the Tax Bill

Another detractor to dividend investing is taxes. Unfortunately, each and every dividend payment is viewed as income in the eyes of the IRS so taxes are incurred at each occurrence. Those opposed to dividend investing will be quick to remind you of this fact. By electing to participate in an asset that doesn’t pay a dividend the only tax consequence (or benefit if it’s a capital loss) happens when the investment is sold. I’m far away from being a tax expert so it’s imperative you speak with someone more knowledgeable but I certainly understand the stance. I don’t prefer having more money taken from me than is absolutely necessary.

Choosing to invest in dividend paying assets means building an investment strategy to account for the tax implications. Again, there isn’t a one size fits all approach but my simple side step was to just place my highest dividend payers into a Roth IRA. A quick and easy fix to having an inappropriately sized tax liability.

Yield Chasing

This is where most, including myself, stumble as dividend investors. I mean, who wouldn’t prefer an asset that pays 10% rather than 3%? It’s all too easy to chase the yield, as they say. However, doing so is generally a bad idea as those companies are paying out way more in dividends than they can sustain.

As a general rule of thumb, I’d pay careful attention to those assets paying more than 3-4% a year in dividends. The companies paying a disproportionately larger dividend are likely doing so for a reason. The reason is so you’ll invest. Only later do you find out the company is struggling or worse they just randomly cut the dividend without prior notice. Either way, its my opinion, these companies don’t deserve our investment dollars.

As a sidenote – I’ve seen investors successfully chase the yield but they don’t do it for the long term. More often than not these investors are chasing the payout for a predetermined period of time before eventually moving on. That said, stay to long and you’ll quickly understand why chasing yield can and does have a unique sting.

Final Thoughts

In the end, whether dividend investing is right for you is up to you. I’ve explained many but not every consideration there is to dividend investing. The upside is, we’re never locked in to just one approach over another. I’ve personally decided to incorporate several different investment techniques into my own approach and you can have a look at my portfolio here if your interested.

Dividend investing can be a valuable component of a well-diversified portfolio but it isn’t the only avenue to consider. There are drawbacks to just about everything in life and I’ve mentioned only a few as they relate to this investing style. By understanding the potential pitfalls, you’ll be able to make informed decisions about whether they make sense for you or to what level they could make sense.

I hope you were able to take something away from this post as you consider the dividend approach. If you did or even if you didn’t please leave me a comment below to let me know. I truly enjoy hearing from other investors and it’s the only reason I do this. There aren’t many people I know personally that I can talk to for hours about investing so hearing from others like me is worth every minute I spend creating the content here.

Until next time.

God bless,

Jeff

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