Now, on to the fourth of five foundational investment styles, dividend growth investing. Of the many popular investment styles, dividend growth investing may just be a little of every style rolled into one. I suppose ultimately that will be for you to decide but it’s an investing method that fits me very well and one that I’m currently implementing in my own portfolio.

Let’s get into the details and when we’re done you’ll have a fantastic understanding of the dividend growth technique and it’s many benefits.

As always, I’m not a financial advisor and this isn’t a recommendation. Just my attempt at highlighting some of the critical elements to an often misunderstood investment style.

Post Contents

• Growth or Dividend Growth?
• Compounded Returns
• Staples and Income
• Performance Qualities
• Risk Management
• Passive Income
• Yield & Payout
• Growth Prospects
• Diversification: Do I need it?
• Dividend Kings, Champions, Aristocrats, Contenders, & Achievers
• Uncle Sam & the Tax Bill
• Downsides to Dividend Growth Investing
• Dividend Cut, oh my!

Growth or Dividend Growth

Not to be confused, growth and dividend growth are indeed two separate concepts. I discussed growth investing in detail here, growth investing 101. Dividend growth investing however is in regards to a dividend paying company consistently raising their dividend payment. Not necessarily a growing share price or revenue growth. A key difference that shouldn’t be misinterpreted.

While both styles of investing can experience share price appreciation, dividend growth investors generally prioritize those companies keen to increase their dividend payment at regular intervals. The allure, is the ever growing passive income stream. Possibly one of the easiest avenues to earning an income. Many investors seeking this style of investment have big dreams of one day living comfortably from the dividends alone and with many years of dividend growth they may just be on too something.

This style of investing isn’t new and it’s an approach that has stood the test of time. Many are the investors before us that have used this method to weather difficult economic periods. The advantages to dividend growth investing are mostly clear to see as passive income abounds. Although, with every investment there are downsides and we’ll discuss several ahead.

Compounded Returns

As is the case with dividend investing or income investing, dividend growth investing at it’s core aims to parlay this growing cash dividend into a veritable cash printing press. The ability to re-invest this additional capital is, in my mind, similar to a company retirement match program. Only here, the employer, or the business as it were, is matching at an increasing rate. Not generally something you’ll see from an actual employer match program.

Still, the power of re-investing these seemingly modest raises can have an outsized impact over an investment lifetime. Feel free to play around with this dividend growth calculator to get an idea what may be possible.

For example, a $10,000 dollar investment with $500 contributed each month would grow to nearly $1.3 million if the return average was 7%. Additionally, the income each year would total more than $150,000. Shocking to see but the math is there. The real question is whether our investments can earn that 7% year over year return and whether we’re able to stay the course through good times or bad.

That said, historically the S&P 500 returns approximately 10% each year so I do find some comfort in that. For fun, averaging 10% YOY would result in a portfolio value of $1.9 million and an annual income of $235k. These calculators are always fun but only time will confirm their worth. In my experience, real world math can be dramatically different than spreadsheet math.

Staples and Income

Generally speaking, dividend growers are already established firms dominating a particular market segment. Think Coca-Cola or Walmart. While much of their growth has already been experienced these companies agree to return an increasingly larger dividend to shareholders as an incentive. When inflation or prices increase so too does revenue generated from these firms. Often, these companies have become so dominate in their respective spaces it would be virtually impossible for another to supplant them.

By investing into a dividend growing asset, investors may take refuge knowing their vehicle of choice isn’t easily eliminated. And in a market rife with uncertainty, that can be a deciding factor.

Companies able to consistently grow their dividend mean shareholders income increases on auto-pilot. Making dividend growth investing, frankly, unmatched in that regard by other investment philosophies. This additional income could be used even during prime earning years to pay bills, take vacations, or simply be re-invested. The possibilities for what to do with the additional capital remain yours but if history or those dividend calculators are to be trusted, re-investment is probably best.

Before I move on, it isn’t necessarily common for a company to have experienced this level of growth or success and there is no guarantee they’ll continue to in the future. As such, companies paying an ever increasing dividend are usually those providing products or services to our every day lives. Similar to the above mentioned Walmart or our electricity company. Meaning, careful thought should occur before becoming too heavily invested into a relatively small subsection of a much larger market.

Performance Qualities

Considering what we already know with regard to dividend growth investing much of their future performance may well be tied to their dividend increases. As discussed, companies having grown their dividend for 10, 20, 30, or even more years aren’t the status quo. There simply isn’t enough market for every company to achieve this status. With that, it remains imperative that a potential investor consider fully the performance characteristics of an asset. Or said another way, potential for underperformance in comparison to another asset or investment technique.

History is on our side however with stories as outlandish as uncle Ned’s record breaking bass catch that somehow magically, “got away”. The difference though, many of these stories are true and we all know Ned didn’t catch more than a buzz!

There are indeed many truthful studies having shown dividend growth stocks outperforming their non-dividend counterparts. For example, here is an article from Hartfordfunds.com with several references about the power of dividend growth over time. The key takeaway is that much like the entire stock market, dividend growth stocks ebb and flow in and out of favor among investors. Still, the performance is plain to see and over time a growing dividend re-invested can perform admirably.

Risk Management

No matter the investment style we adopt risk mitigation should remain at the forefront of our decision-making process. Having learned from experience that neglecting risk is a costly mistake. Established dividend growers are inherently risk averse since most operate, as mentioned, in markets we need in good times or bad. I honestly doubt people are going to stop needing Johnson & Johnson’s motrin during a time of recession. If anything, those sales should improve.

Dividend growth investing, in a way, knocks down several birds with one stone. It allows an investor the opportunity for growth, dividend growth, and to some extent an internal risk control mechanism. By investing into dividend growth assets an investor may find additional comfort knowing two simple truths. One, these companies can still thrive during a contractionary economic period. Two, dividend growth stocks often find favor among other investors during heightened periods of uncertainty. Characteristics hard to find elsewhere except maybe bonds, treasuries, or other fixed income investments. Which, by the way, don’t offer even a hint of growth above their current rate.

Lastly, and the very reason to consider dividend growth investing, is the dividend. During uncertain periods, true dividend growers maintain and even increase their dividends like clockwork. With a steady income stream, favor during economic turmoil, and a non-stop revenue stream, dividend growth investors may prove to be the most prepared investing class of them all.

Passive Income

Simply stated, passive income is money earned that we haven’t lifted a finger to receive. Possibly the greatest form of income, passively earning is what millionaires, billionaires, and even trillionaires are made of. Those claiming this title have done the work and now receive their “mail box money” as I’ve heard it called.

Dividend growth investing fits comfortably here in that as an investor the only work we’re required to do is invest in a similar asset. After that, the investment will spin off income at regular intervals and no additional input would ever be required. However, most choose to re-invest their passive income back into the holding or into a similar broad index with the intention of compounding the investment.

No matter the desired use for this stream of income those choosing to invest into dividend growers are increasingly rewarded for having done so. A facet no other investment class could claim.

Yield & Payout

Yield as it’s commonly referred, is a measure of the dividend amount compared to the current share price. For example, a company with a $100 share price and a $2 annual dividend would have a dividend yield of 2%. $2/$100 = .02 or 2%.

Payout or payout ratio is a measure of a companies earnings paid out as dividends, expressed as a percentage. For example, suppose a company’s net income was $1 million and it pays out $100k in dividends the payout ratio would be 10%. $100k/$1 million = .1 or 10%.

Either metric is well regarded among dividend growth investors. The yield indicating what amount they’ll receive as a dividend and the payout reflecting the sustainability of that dividend. Specifically, investors may pay close attention to the payout ratio for signs of trouble to a payment or for confirmation future dividend hikes are warranted.

Both metrics offer investors insight but yield is probably the most touted metric across the investment landscape. From Youtube to the bus stop you won’t find anyone unwilling to boast of their investment yield. Similar, I think to uncle Ned’s fishing stories!

Growth Prospects

If there were a lacking quality to dividend growth investing this is it. A quick search across the web will showcase what I mean. Differing investment camps have verbal death matches surrounding this topic.

On one side, dividend growth investors are quick to claim that what they lack in share price appreciation is accually returned in the form of dividends. And by re-investing those dividends the investment decision is sound. On the other, growth focused investors are equally as quick to showcase their Nvdia investment compared to the likes of Coca-Cola or similar.

Akin I believe, to the speed vs comfort argument. In my 20’s give me a corvette, no question. In my 40’s, no thanks, I’ll take the pickup truck every day of the week.

While that battle may rage on for a millennia, it isn’t uncommon for dividend growers to experience a sub-optimal share price return. Making it a key consideration for possible dividend growth investors. No and any decision but a necessary one.

I suppose there are more than a few success stories of investors having successfully navigated differing investment styles but that isn’t necessarily the norm. Should a mixed approach be preferred the benefits to dividend growth investing may ultimately be negated. However, any philosophy is more than fine, so long as it fits your personality and risk tolerance.

Diversification: Do I need it?

Well, yes and no is probably true. Dividend growth investors may find themselves under diversified at times as dividend growth investments occupy a relatively modest corner of the total market. With attention however this shouldn’t be a meaningful detraction. Any investor can surely build a portfolio that spans various segments or sectors.

That said, those with experience may find diversification to be a rather limiting factor. As one asset soars another sours, effectively neutralizing a portfolio. Those with the fortitude and foresight to avoid mistakes may find that under diversification could just be a catalyst to outsized success.

Whichever is decided should align well with the investors goals for the future and their portfolio. More conservative investors may seek to minimize volatility and increase diversification where more aggressive investors opt for less. The downside, if we want to view it this way, would be lesser diversified investors would need to stay abreast of changes and respond quickly.

Personally, I prefer an over diversified approach which you’ll see from my portfolio here.

Dividend Kings, Champions, Aristocrats, Contenders, & Achievers

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

• Dividend kings – Have increased their dividend payment for 50+ years.
• Dividend champions – Have increased their dividend payment for 25+ years.
• Dividend aristocrats – Have increased their dividend payment for 25+ years and are in the S&P 500.
• Dividend contenders – Have increased their dividend payment for between 10 – 25 years.
• Dividend achievers – Have increased their dividend payment for 10 years.

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.

Uncle Sam and The Tax Bill

No investment philosophy discussion would be complete without taxes. Dividend growth investing isn’t a preferred strategy if taxes are to be avoided. Every dividend can trigger a potential tax event and opposition to dividend growth as an investment method will be sure to remind you about taxes frequently.

Still, an investor would be well served having familiarized themselves with the various account types available today. More than a few receive favorable tax treatment and others, like a Roth IRA, eliminate tax concerns entirely. Here is a site listing many of the different investment account types or you may speak with an existing brokerage to determine their unique account offerings.

For me, the approach to avoiding an outsized tax bill was to simply hold dividend payers in a Roth IRA account. An easy fix to otherwise uncomfortable trait of this investment style.

Downsides to Dividend Growth Investing

The downside to dividend growth investing will differ depending on where you look or who you ask. However, as I discussed in my dividend investing 101 article and as I’ve mentioned here, the greatest downside is subpar growth. Though the evidence suggesting this generally fails to properly evaluate the re-investment of dividends it must be considered before wading out into dividend growth waters.

Another area dividend growth investors must always be cognizant of is the health and stability of the dividend being paid. Companies can easily mis-step in one way or another or the market may change, rendering a product or service less desirable. In such a scenario, the dividend payment may become a question mark. For those seeking a stable portfolio with an actual growing dividend, a dividend cut is never welcome.

Under diversification is also a downside to the dividend growth investment method. Those seeking this style of investment would do well to account for this in the research and planning phase of an investment. With consideration given, not only to the current yield or to the dividend growth but also to the construction of an entire portfolio. A portfolio of assets able to withstand every market cycle, regardless the dividend growth, may be an under appreciated target.

In all, investing means an acceptance of risk and that risk can take many forms. Much of which is focused on choosing to invest in one place over another. The opportunity cost of dividend growth investing couldn’t truly be quantified but if history is any indication, those concerns may be unwarranted as cashflow is generated and re-investment occurs.

Dividend Cut, oh my!

The greatest pitfall to dividend growth investing, in my opinion, occurs when an asset unexpectedly lowers a dividend payment. Further, it isn’t uncommon for a struggling company to minimize their dividend upwards to 50% or more. Adding perspective, consider a company with a 3.5% dividend yield. Suppose troubled times strike and the payout ratio rises to 90%. In this scenario, the company is paying the majority of their earnings out as dividends. In this situation, the company will likely choose to eliminate some portion of their dividend. Hardly a recipe for a successful dividend GROWTH portfolio.

Consider also the negative sentiment you’ll experience having built a position up over years of dividend re-investment. Basically meaning, you wake up one day to find an income stream has been cut in half. An expected $10,000 dollar dividend payment turning to $5,000 could mean some very difficult life choices.

All together, while dividend cuts do happen they are possible to avoid. Careful planning around desired assets and an awareness of portfolio holdings would stave off most unwelcome surprises.

Final Thoughts

Dividend growth investing has proven time and again to be an investment philosophy worthy of consideration. The potential for a steady stream of growing passive income will likely always be a desirable characteristic amongst investors. Though, as with any investment approach, it’s imperative that an investor recognize potential hurdles and seek to avoid or remove them entirely.

Dividend growers may have historically outperformed the market but there is never a guarantee. A method I’ve personally adopted, is balanced mix of the different investing styles. I prefer an aggregation of growth investing, dividend investing, income investing, dividend growth investing, and value investing. I am however not an advocate of boundlessly moving from one style to another.

In all, dividend growth investing is hyper focused on a growing dividend. With mindfulness toward risk, investment objectives, and time horizons investors may equip themselves with a stable, recurring, and ever growing income stream. More than capable of lasting a lifetime.

Until next time.

God bless,

Jeff

<p>The post Dividend Growth Investing 101: Build Wealth Through Consistent Income first appeared on UQinvest.com.</p>

Let’s talk income investing, what it is and why it might make sense to include in our portfolio. If cash is king, then cashflow is queen? I’m not sure, but income investing is certainly about cash flow generation. In this post you’ll find a great many reasons why income investing may or may not be a useful investment approach.

Before I get ahead of myself, this post is not a recommendation to participate in any strategy. I’m just a stranger on the internet sharing some knowledge. Always check with a professional or fully consider the consequences before investing.

Post Contents

• Cash Flow
• Diversification
• Compounded Returns
• Asset Classes
• Risk Management
• Strategies
• Laddering Investments
• Uncle Sam and the Tax Bill
• Derivative Strategy Investments
• Downsides to Income Investing
• Interest Rates & the Federal Reserve
• Inflation: the Masked Bandit

Cash Flow

If you’re seeking a consistent income stream then income investing is one viable solution. By investing in assets that return a higher than average yield the investor will regularly receive income from such an investment.

Historically, cashflow is returned on a quarterly basis but monthly payouts are becoming more common. With the return of higher interest rates, more investors are turning to treasuries or bonds to both protect their capital and keep up with inflation. These assets commonly make coupon payments or return interest on a monthly basis. Because of this, many new income investment opportunities are electing to participate monthly as well. Additionally, several new investment vehicles have introduced the option for weekly dividend payments to make cashflow management easier than ever before.

Cash flow is the process of cash flowing from one hand to another. In this case, cash flowing from the investment back to the investor. How that cash flow is returned though is important. Most would prefer the dividend be paid as a qualified dividend but the reality is most assets designed for income do not. Rather, the capital is returned to the investor in a few ways; return on capital, non-qualified dividend, or interest income. All of which are considered ordinary income. We’ll talk more about this later but in short, ordinary income is generally taxed at a higher percentage.

Diversification

This can be a trigger word for many investors. Some demand it and others despise it. The argument in favor states that through a well diversified portfolio an investor will weather market turmoil with differing assets offsetting one another. The later contends that diversification limits return and is only suitable for someone lacking proper understanding.

Nevertheless it’s an important consideration prior to beginning any investment strategy. Fail to diversify sufficiently and the result could be a substantial loss of capital. Alternatively, over diversify and it’s difficult to get ahead as portfolio laggards continue to draw down potential capital gains.

With income investing, diversification can be a critical component to a successful investment. In my Unqualified Portfolio, I’ve opted for my income account to include a growth driver and several different income assets with a lesser allocation. I am however, mildly overweight in the financial sector as I attempted to diversify positions. I would have much preferred a closed end fund to minimize that concern but Robinhood doesn’t currently allow trading of closed end funds. For those interested, I have enjoyed good success with the Eaton Vance offerings.

Compounded Returns

As is the case with virtually every investment, investors seek to compound their returns over time. This is especially important to income investors if the goal is portfolio growth. However, most income focused investors are retired or nearing retirement so growth is usually a secondary concern. For them, safety of their principal balance and the generation of cash are the main attraction.

For those seeking growth, compounding the dividend payment by investing into additional shares can mean an ongoing income increase. Or as some view it, a pay raise! At every interval, investors not needing the cashflow today can simply put it back to work to generate a higher payment at the next payment date. Couple that with capital appreciation and the prospect for a healthy long term portfolio is clear to see.

For those seeking income, compounded returns is of lesser importance. While not out right neglected, income investors have identified the amount of cash flow they’ll need and maintaining that amount is the goal. In an ideal scenario, an investor would aim to generate enough cash flow to cover expenses while still returning a portion to the investment for growth.

Ultimately, it depends on what phase of life you’re in. Income investing may make great sense for those in retirement or nearing retirement. For those not there yet, income investing would be a reflection of risk tolerance and strategy to determine viability. I’ve personally adopted income investing for the sole purpose of paying for summer vacations. In theory, and given the accounts construction, I would be able to spin off enough capital each year without ever sacrificing the principal balance.

Asset Classes

The list of classes related to income can be long and their are nuances to each. Rather than a 100 point list I’ll highlight a few of the primary classes for initial consideration.

• Treasuries
• Bonds
• Corporate Bonds
• High Yield Equities
• Real Estate Investment Trusts
• Closed End Funds
• High Yield Accounts or Certificates of Deposit

Again, this isn’t an exhaustive list. Rather, I hope it provides a relative starting point for someone thinking of entering the income investing domain. I’ve also added some relevant links to each of these points to conduct further research. Otherwise, I’d turn to Google or any one of the many AI tools for queries related to income asset types.

Risk Management

Likely the most important component to any investment strategy. It’s important to never step too far over the risk tolerance line or you’re sure to lose sleep and begin sipping pepto-bismol instead of sweet tea. In my opinion, the bulk of this is handled prior to ever having invested a single dollar. It’s never advisable to invest capital that cannot endure market fluctuations. Said another way, don’t invest money that cannot be lost.

That sounds a lot gambling, I know. The reality is we never know when the next market surprise may occur. Imagine waking up the day everyone found out about covid-19 only to see your investments down 20-50%. If you wouldn’t be able to endure a similar scenario then it’s likely you’re assuming too much risk. For comparison, those that were able to whether the storm have enjoyed an epic bull market and the returns to match.

With regard to income investing, several different risk factors must also be considered depending on the type of asset selected. Interest rate risks, credit risks, concentration risks, and general market volatility are all necessary ruminations prior to income investing. As is the case with any investment strategy, an understanding of the potential risks aligns itself with the probability for success.

Strategies

Another broad concept for income investors to surmise would be which strategy makes the most sense for a presumably limited amount of capital. The number of strategies is as unique as the hairs on your head so there isn’t a one size fits all approach. Many income investors opt to alter common strategies in pursuit of their own established goals. Doing so can increase the complexity but also provide the expected reward.

Some common income investing strategies include;

• Building a diversified bond portfolio
• Investing in a diversified basket of dividend equities
• Savings in a high yield account
• Real estate investments
• Fixed income laddering
• Covered call or cash secured put writing
• Building a multi-asset income approach

I’ve personally opted for the multi-asset approach or as I see it a multi-bucket strategy. Where some money is in a savings account earning a smaller interest, some is in treasuries earning slightly more interest, and some is in the market via equities, REITS, or derivatives. A more complex approach but one that suits me and manages risk based on time horizon.

Laddering Investments

Typically reserved for fixed income assets laddering is an investment strategy whereby the investor staggers the maturity dates of an investment.

Consider a certificate of deposit (CD) investment;

An investor wanting to ladder such an investment would hypothetically invest $1,000 into a 1-month CD, $1,000 into a 3-month CD, and $1,000 into a 6-month CD. In this way, the investor would receive their balance and interest at the end of the identified periods. Should interest rates rise, they aren’t locked in to the lower rate and should they decrease they still have a higher rate on some of their invested capital.

Additionally, laddering may also be used elsewhere in the market. For instance, income investors routinely identify preferred assets based on payment dates. Through careful structuring of a portfolio an investor can reduce variability and provide an expected income stream at predetermined intervals. A valuable concept for those choosing an income investing approach.

Uncle Sam and the Tax Bill

I’ve heard it said that those who intend to remain wealthy must have an understanding of taxes. Whether that’s true or not is up to you but it is true that the government will take as much as much as it possibly can. Therefore, it must also be true that we demand to keep as much as we can.

Now, I’m not a tax professional and there really is no substitute for consulting with a tax authority. They have more knowledge and unique strategies at their disposal to minimize uncle Sam’s reach.

That said, dividends are generally viewed as a taxable event. There are unique circumstances when capital is returned that may not be taxed as income but by in large taxes are incurred at each dividend or interest payment. As such, it would be a great oversight to neglect the tax liability while structuring an income focused portfolio.

There are several tax advantaged accounts that an cashflow investor should consider with the most well-known being, Traditional and Roth IRA’s. I’ve personally elected to hold most of my higher paying assets inside a Roth IRA to avoid any undue tax burden. However, there are several other account types that may be of interest if they’re available to you. Here is an articles listing several different tax advantaged accounts.

Derivative Strategy Investments

As investors grow and change so do the products available to them. As of today, there is an emergence of income producing assets focused on the use of options to generate higher than usual levels of income. The concept isn’t new but the number of investable assets of this type seems to grow each day.

In short, options are a derivation of the underlying security. Offering an investor the opportunity to mitigate risk, speculate, or generate an income. Through strategic covered call campaigns or cash secured puts an options investor may generate an additional 10-20% of income from an investment. Of course, there is no free lunch and options have unique risks and characteristics but that hasn’t stopped the onslaught of these assets.

There are several types of derivative strategy investments available but the most common utilizes a covered call system to generate additional income. Meaning, these investments can achieve upwards of 40% or even more in yield per year. Making the risk of principal erosion an important focal point. In fact, most assets in the space have a declining share price and are not intended for most investors.

Still, they offer an income investor plenty to consider. Personally, I’ve elected to use them as the smallest portion of my income producing account with hope they will meaningfully boost the income without completely destroying the total return profile. The later is still in progress though so more time is needed for me to fully evaluate this class of income producing assets.

Downsides to Income Investing

As is the case with literally every investment. Income investing isn’t without a fair number of challenges. Many of which make this approach one several investors simply say, “no, not gonna happen in a million years”. For them that is the correct response. Their risk tolerance or goals may be harmed adopting such a technique.

Of the common detractors to income investing, here are a few;

• Limited Growth Prospects
• Interest Rate Risks
• Concentration Risks
• Credit Risks
• Opportunity Costs
• Capital Erosion

Most of these have been discussed previously but as a brief review, income investing can limit the growth potential of an investment. Assets paying out an above average income typically don’t see explosive capital appreciation. In fact, the lesser desired outcome is more often true. Many of these assets face share price erosion over time and thus a poor investment choice for a great many investors.

The risks discussed earlier are the same here. Concentration risks essentially highlights the tendency for an investors to place more capital than they otherwise would solely for the benefit of a higher yield. Credit risks are really an evolution of the 2008 financial crisis, in my opinion, when the world took notice that corporations shouldn’t be trusted. In essence, credit risks arise when the institution defaults on its obligations.

Also true for any other investment is the opportunity cost. For example, suppose an investor elected to deploy a treasury ladder at 5.35% interest over the next year. So long as the US government didn’t default they would enjoy the payout from that ladder over the time period. Alternatively, they may have invested in Microsoft(MSFT) and earned 15% over the same period. Obviously, Microsoft performed better in this scenario. However, the opposite could also be true and Microsoft could have declined instead. The opportunity cost arises as an investor selects one avenue over another.

Interest Rates & the Federal Reserve

The Federal Reserve(FED) is the US’s central bank, established to create a stable monetary policy and financial system. As the FED raises or lowers interest rates they have an impact on the economy. Effectively impacting people and businesses ability to borrow. When interests rates are low, the idea of borrowing for a house or for capital expenditures becomes more enticing and therefore a boost to the overall economy. On the other side, when rates are higher or more restrictive, less borrowing occurs and as a result, less expenditures. The role of the Federal Reserve is to attempt a balance between the spectrum of accommodative and restrictive policy.

For income investors, the Federal Reserve Rate is of unique importance. As they raise or lower this rate, our income can also raised or lowered. For example, consider a bond investor deciding to invest when interest rates were relatively low. As the rate rises, the value of this investors bonds will decline because newer bonds offer a higher yield with the new higher rate. This may result in a capital loss to an investment largely considered safer than other assets on the risk scale.

In all, it remains important for income focused investors to stay abreast of changes or the possibility of changes to the Federal Funds Rate. I don’t personally believe it should be the primary consideration but it can not and should not be ignored.

Inflation: The Masked Bandit

Inflation can best be compared to rust. It’s the slow but ever present corrosion of our asset or our purchasing power over time. For context, $1,000 dollars in the year 2000 is the same as $548 dollars in 2024. In the past 24 years our purchasing power has declined by roughly 50%. For those opting to put there money under a mattress, they now have far less money than they once did.

Inflation is generally viewed by most Americans negatively. The idea that our money buys less over time isn’t a great quality, I’ll admit. However, had the investor that put that money under his mattress earned only 2-3% his money would still be as valuable today. Had this investor invested it in the S&P 500 his $1,000 would now be worth $2,533. Effectively beating inflation and earning a nice return.

Final Thoughts

In the end, whether income investing is the correct approach for you boils down to your risk tolerance, goals or objectives, and management ability. For me, income investing is a staple of my investment approach. All be it, to a much smaller extent. Still, the approach is one many investors enjoy each day as they’ve structured their holdings to provide for their lifestyles.

Income investing, like all forms of investing, has risks associated. Not understanding those risks or neglecting them all together is sure to bring financial loss. However, with careful consideration and a strategy for implementation it is possible to generate a stable, recurring cashflow portfolio.

By maintaining adequate diversification, conducting regular portfolio reviews, and staying abreast of economic changes investors can harness the power of income investing to achieve their financial goals.

Until next time.

God bless,

Jeff

<p>The post Income Investing: Building Steady Cash Flow first appeared on UQinvest.com.</p>

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.

Post Contents

• Power of Dividend Investing
• Passive Income
• Compounded Returns
• Dividend Growth
• Defensive Characteristics
• Quality over Quantity
• Dividend Reinvestment
• Dividend Kings, Champions, Aristocrats, Contenders, & Achievers
• Downside to Dividends
• Uncle Sam and the Tax Bill
• Yield Chasing

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;

• Dividend kings – Have increased their dividend payment for 50+ years.
• Dividend champions – Have increased their dividend payment for 25+ years.
• Dividend aristocrats – Have increased their dividend payment for 25+ years and are in the S&P 500.
• Dividend contenders – Have increased their dividend payment for between 10 – 25 years.
• Dividend achievers – Have increased their dividend payment for 10 years.

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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