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 all of us. 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 continue 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 realized 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 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 given 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 every day 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 believe 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?