In an ideal world, we would be able to invest the exact same amount of money every month, and then every year, we would be able to increase the amount of money available to invest. If things went perfectly, we would be able to "wash, rinse, repeat" this formula for 30+ years until we are prepared to retire. Unfortunately, life happens, and we cannot always invest as much money as we would like at a given point in time.
The good news for us as investors is this: even if we are dealing with a temporary bump in the road that prevents us from investing $500 per month (or whatever the amount may be), once we get our hands on productive assets that churn out income, they continue to produce for us even in the moments when we do not have surplus funds available to deploy.
Imagine if you spent the past five years building up a tax-advantaged account with 300 shares of General Electric (NYSE:GE), 50 shares of Chevron (NYSE:CVX), 250 shares of Coca-Cola (NYSE:KO), 100 shares of Johnson & Johnson (NYSE:JNJ), and 200 shares of BP (NYSE:BP).
Comprehensively, you would automatically be generating: $228 in annual dividends from General Electric, $200 in dividends from Chevron, $280 in dividends from Coca-Cola, $264 in dividends from Johnson & Johnson, and $432 in annual dividends from BP. Those five stocks would combine to generate $1,404 in annual income for you to deploy elsewhere, and considering that each of those companies raised dividends last year and are expected to have higher future earnings next year, it is realistic to assume that you will receive a dividend raise from each of those five companies in the next year.
But the important thing is this: once you acquire an ownership stake in a productive asset that shares its annual profits on a regular basis with you four times per year, you continue to receive funds to deploy elsewhere even if something happens in your personal life that prevents you from adding more funds to the market at the moment.
If our investor had spent the past couple of years buying a couple hundred shares of an excellent company like Berkshire Hathaway (NYSE:BRK.B), he would be powerless to make any capital allocation decisions at a time when he was not generating surplus funds to invest. That is because all of Berkshire's profits are tied up internally and being allocated by Warren Buffett (that is not a bad place to be in, but nevertheless, it does not provide you with an opportunity to make new capital allocation decisions).
The fun thing about stuffing your tax-deferred account with dividend stocks is the fact that, as long as the company remains profitable and the Board of Directors continue to declare dividends, you receive new amounts of passive money to invest, even if you are not able to generate surplus capital yourself at that given point in time.
The example above generated $1,404 in "free" money for you to invest, even though you were not able to come up with new funds from your labor. If you put that $1,404 in something like Royal Dutch Shell (NYSE:RDS.B), you would be able to pick up 20 shares generating $72 in annual income of its own. That is what makes dividend investing so appealing to investors: even if you stop feeding the beast, the money still flows (in this case, $1,404 worth of it).
Charlie Munger, the Vice Chairman at Berkshire, once said, "Saving up the first $100,000 is a mother." He was absolutely right. If you only $5,000 in investments generating 3% in income, you are only bringing in $150. At that point, you are pretty much dependent upon your labor to generate money. However, once you own $100,000 worth of productive assets, you'd be looking at $250 in investable assets being generated every additional month you stay alive.
Personally, I would modify Munger's advice to this: try to get $150,000 in a Roth IRA by the time you are middle-aged that is generating 3.67% in annual dividends. What is so special about those numbers? At that point, your Roth IRA would effectively be funding itself even if you found yourself unable to contribute one year. Your established holdings would be bringing in $458 for you to invest each month, and even if you were never able to invest again, you would still have those assets churning out and growing their income while immediately receiving $5,500 in immediate annual income that could easily be invested to add $200 per year in additional income to your base if you chose a dividend payer yielding at least 3.67%.
When you look at how Warren Buffett structures incentives at Berkshire Hathaway, you can see that it is all about arranging affairs in a way that constantly brings money through the door. The managers at the operating companies receive bonuses based on the amount of money they are able to send to Omaha each year. Berkshire's largest holdings have storied, if imperfect, histories of sending profits to shareholders. The constant capital infusions create the oxygen that allow Buffett to breathe life into new investments.
The same principles may hold true in your own investing life. It can be nice to get yourself in the habit of having money coming in each month that allow you to make new investments. Typically, those funds may come from the surplus that results from your actual labor. But the good news is that when you are dealing with productive assets that generate dividend income, there is still money coming through the door even when you cannot generate the surplus founds yourself.
Disclosure: I am long BP, GE, JNJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.