Why Income? How Dividends Bring Wealth

Summary

• Investing philosophies need to be grounded in history.
• We look at how wealth was created through the ages.
• Today, your brokerage has an agenda on how it presents its data. Does it align with your investment philosophy?
• Looking for a portfolio of ideas like this one? Members of High Dividend Opportunities get exclusive access to our model portfolio. Learn More »

adventtr/E+ via Getty Images

Co-produced with Treading Softly

Today, I want to take a step back and look at why we do what we do. As many of you know, we focus on what we call "historical wealth generation." This is a return to how wealth was generated or created many years ago. I'm constantly surprised with how often old ideas are "rediscovered" or "recreated," but in essence, we learn that this "new idea" is not so new.

I love to say that our Income Method is unique. It truly is. However, it has its foundation firmly planted in the past and the history of how economics and wealth generation were formed.

For some of our more seasoned followers, this is going to sound familiar, but it's always important to return to the basics and ensure your thought processes haven't slipped away subtly from the foundations laid on why we do what we do. This is going deeper into the why and philosophy of our methods, rather than telling you the how or what to do.

A Firm Foundation Is Essential

Have you ever tried to build something solid and stable on sand? It's hard to do. Sand is not a stable or sturdy foundation. It shifts easily, destabilizing anything above it. The wind can pick it up and carry it off. The waves of the shore, or floodwaters, can move large amounts of it.

Growing up, we often sang a song about two men, deemed wise and foolish, who were building something. You might have sung it yourself or know the underlying story behind it.

The wise man built his house upon the rock, and the foolish man built his house upon the sand. When a storm came and battered the homes, the wise man's home stood firm on its rock-solid foundation. Meanwhile, the foolish man's house went splat!

The issue with building your foundation on the new or revolutionary is that rarely has it ever been tested. Those quick to jump to the new are forced to rebuild their structure often. Anytime a storm hits a building built upon a weak foundation, disaster is sure to follow.

So what did we do? We did exactly what I think so many investors and retirees need to do. We looked past the last few decades of economic thought. We skipped over 100 years of investing perspective. We went back to the beginning. How was wealth created originally? We kept asking and digging.

You see, our economy is not revolutionary or new. It's built upon centuries of development. It's been formed and informed by trials, successes, and disagreements. Before people could sit down and discuss how much a baseball card was worth, we had to ensure that food was available and the basic necessities were available.

Principles are timeless. Applications are timely. We need to travel backward in time to understand the foundational principles of wealth generation so that we can apply them practically today.

A Long Long Long Time Ago... In a World Not Too Far Away

We need to take a trip down history lane for a second, leaving our city and sedentary lifestyles behind, taking a turn past the beginning of agriculture societies, and landing firmly in the hunter-gatherer stage.

During the hunter-gatherer era, wealth was not determined by the size of your rock horde or the ability to storehouse goods. The miracle of refrigeration was not discovered yet, food rotted quickly, so they were forced to constantly be looking for more. The ability to hunt and gather effectively wasn't a one-off skill, you had to be able to do so repeatedly. Beginner's luck didn't allow you to live like a king for decades, and there weren't really any kings back then anyways. Like a recurring income stream, wealth was determined by those able to continuously use their skills to generate the needed results.

Source: Wikipedia

As cultures moved into farming and agrarian societies, the ability to hunt and gather diminished in perceived value, but the ability to plant crops and raise animals rose. Here again, storehousing vast amounts of grain or meat were not the principal determiner of wealth, nor was owning vast swaths of land. It was the productivity of your land, crops, and animals that separated a subsistence farmer from a wealthy one – the functional ability of those assets.

Now the wealth-producing asset was not just your abilities, skills, and talents, but also the ability of your assets – your land and animals - to produce more. As time and technology improved, so did the output of those farms and lands.

Over time, the focus has shifted from generating recurring products to storehousing "riches." This largely occurred as towns developed and trade became important. We attributed value to coins, bills, and precious metals. Then we viewed those people with an excess of those items as "rich." Over time, riches were accumulated by those who had an excess in the functional production of their assets. The landowner with productive land could have the excess income stored in those items attributed with value. As time went on, that successful landowner saw his idle assets grow, and his functional assets grow as he bought more land and farms.

Consider the works of Jane Austen for a moment. In Pride and Prejudice, suitors for the main character were evaluated by their recurring income. Mr. Darcy received 10,000 pounds vs. Mr. Bennet's 2,000 pounds. Even at this time, wealth was evaluated by a recurring income stream, not idle cash. Now Mr. Darcy was from a family owning various income-producing assets built up over generations and passed down from one to the next. Creating what is commonly referred to as Old Money.

Source: stlouisfed.org

Jumping years into the future, we saw the concentration of those riches more and more. The successful ones with their hordes of idle cash were using them to buy more assets to generate more cash. Those without cash or assets started to confuse which came first, thus the way we measure wealth changed its meaning. It's not defined as owning assets that accumulate wealth, but it's simply having an excess amount of them. The focus was taken off of the process and moved to the secondary outcome.

Consider Your Brokerage Account

Over time, we moved from the focus on the functional, repeatable income or production to viewing the placeholder of riches as the source of wealth. By design, brokerage accounts cater to those with a high net-worth – aka excess assets vs. debt.

Those with a high Static Wealth – riches, assets, etc. – are the desired clientele, especially since they need to storehouse their money. Newly rich individuals have been trained from childhood by banks that the money should sit idly and earn little interest.

With this group in mind, the brokerage account uses colors to denote good and bad from a Static Wealth mindset. You get rewarded with green numbers when your balance rises. You get red numbers when it drops. Red screaming, stop, do not enter, all wrong!

These colors are carried through our entire life experience. Red light, stop. Green light, go. Red denoting risk, green being all clear. The list goes on.

Yet without a means to replenish this stockpile, the rich are only rich in assets that they can't use lest they lose that "rich" title. Being rich is a state of being, like being ugly. You can change your state of being, but that should not be an end-goal itself when it comes to life and investing.

Retirement is a span of time in which you will have opportunities, risks, and life events. Your amount of idle cash does nothing for you if you cannot spend it or replenish it. Being rich gets you nothing, no pin, no hat, no special fan club.

Consider bank and other "safe" deposit account options, the interest rate they pay has dropped over the years. It's supply and demand. The more retirees keep in their savings accounts, the fewer incentives banks have to pay a higher interest rate. A simple glance at bank yields reveals this trend.

I've seen a very few toboggan hills that looked as fun of a ride as that, but if you depended on CDs to pay for retirement, you've been on a losing bet.

Source: Getty

Return To The Historical Wealth Generation

If you're rich already, congrats! Way to go! It's something no one should ever be ashamed of, and it provides you tools to see even stronger income growth.

If you're like 99% of individuals, you're not rich. That's OK! Most of us aren't.

If you are rich, switching to focusing on recurring income generation greater than your expenses will continue expanding your riches and allowing you more breathing room in your portfolio and budget.

If you're like 99% of people, focusing on generating income exceeding your expenses as a target will bring you better in line with history. The vast fortunes of most of the world's wealthiest were not generated by stockpiling coins in a bank account. The Elon Musks and Jeff Bezos of the world did not get rich by stockpiling wealth. Like farm owners of old, they created their riches and wealth by becoming entrepreneurs and built companies that generate vast amounts of recurring cash flow. Their Functional Wealth – the money their assets earn for them – was the profits of their businesses.

As investors, we're not starting new companies. We're investing in established ones. We demand they pay us for that ownership, that's a dividend. I created the Income Method to help determine which companies and securities to invest in so my hard-earned money keeps earning me more. Nothing makes money like money does.

When we look back in time, we see that wealth is not a result of riches. Riches are the result of wealth. Wealth is simply an excess supply of income over expenses. The more, the better. As that excess supply rolls in and is reinvested, our riches increase. We have more net asset value.

When we approach the market with this mindset and perspective, we can cut through the noise of get-rich-quick schemes or gambling short-term investments. Down days become opportunities to reinvest dividends into companies that are producing recurring income. Up days are days to celebrate the success of our income portfolio. You become in charge and empowered to have a portfolio centered on the key historical tenant of wealth generation. You can establish a multi-generational trend of wealth being passed from one to another and allow new opportunities for your children and grandchildren, should you choose to do so or choose to have them.

At the end of the day, I want you to succeed. To do so, we must know what we are working towards. High Dividend Opportunities is designed to increase your wealth so you can have more flexibility and the best life possible. Becoming rich is the byproduct of a well-run income portfolio, not the goal.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

Treading Softly, Beyond Saving, PendragonY, and Preferred Stock Trader all are supporting contributors for High Dividend Opportunities. Any recommendation posted in this article is not indefinite. We closely monitor all of our positions. We issue Buy and Sell alerts on our recommendations, which are exclusive to our members.

Comments

[Cuip99]

Yes, I am a dividend man. I call it my cash flow, cash flowing into my coffers. It allows me to reinvest in new positions or to expand existing positions. That is my kind of growth.

[PendragonY]

@Cuip99

Me too.

[Rida Morwa]

@Cuip99 Thank you for reading and commenting! Always nice to see you.

[usiah]

@PendragonY

And me.

[steve fishman]

Thoughts on psldx

[Rida Morwa]

@steve fishman It is an interesting mutual fund with a long history of strong performance. Personally, I do not hold any mutual funds nor look too closely at them. However PSLDX does seem like an extremely well run one.

[Qiam]

A great article. Thanks!

[Rida Morwa]

@Qiam You are very welcome.

[twilight4]

I am primarily a high dividend investor who DRIPs (reinvests dividends) but I wonder at times what really is the difference between dividend and non-dividend paying stocks. If you own EPD for example which pays around 8%(2% a quarter) it is my understanding that when you are paid that 2% dividend the price of the stock is then reduced 2%. It would seem that if you owned AMZN instead which pays no dividend you could just decide to pay yourself an 8% dividend and sell 2% of the stock four times a year and it would basically be the same as owning EPD in terms of getting money out of your position anyway. DRIPing (which I usually do for convenience and to keep my money working) does seem like a strange process when you think about it. Again using EPD my understanding is that you are paid the 2% quarterly dividend, the value of the stock is simultaneously reduced 2%, and then your brokerage firm buys back stock with the 2% dividend, so you end up with more shares at a lower price and are basically back where you started from. I have always wondered if some money is lost in the transactions. I am with Schwab and they seem to take a day to reinvest your DRIP so it probably depends primarily on whether the stock price shifts during the lag time. Please let me know if I am seeing this whole process correctly and if you see any fundamental differences between dividend paying and non-dividend paying stocks.

[PendragonY]

@twilight4

The dividend is paid out of the company's cash flow. It doesn't come out of share price. Also don't mistake an action by the exchange to account for who gets the dividend for a permanent reduction in the share price.

[allday1234]

@twilight4 I actually have brokerage accounts with 2 different companies and I do not drip but I do reinvest the money, its just that I choose to pick where The 2 companies are Schwab and Merrill Lynch so I can speak only for those 2. With the Schwab they do not pay on the day of the dividend pay and I believe it has to do with when they run their batch jobs to consolidate the brokerage totals, thus dividend pays do normally occur the day after the supposed payment. With Merrill Lynch the money appears usually 2 or 3 hours before market open on the day of payment With Schwab there has been an occasion when the payment shows up 2 days after payday , but very seldom, thus as someone who drips you would see the delay. I prefer the payment on the day of payment as in certain circumstances it could make a difference in your bur price. Since I do not drip I do not know if the price you would get is reflected on the shares that are dripped at open on the date of payment or the date it shows it was added.
How one uses the reinvestment program is of course personal choice and as one who only has dividend paying stocks. An investor should make up his/her own mind if they want to use it. II say use what ever you are comfortable with.

Wishing you the best

Allday

[TheHornet]

@twilight4
“but I wonder at times what really is the difference between”

You don’t have to wonder, this question has been answered hundreds of times in empirical research and the answer is that once controlling for known equity market factors, dividend yield (and growth thereof) is irrelevant.

In older time series dividend growers outperformed, but it was due to their loadings on the value factor. More recently they have underperformed, mostly due to their very low loading on momentum and the fact that the value premium has disappeared for almost 15 years now.

Dividends are very inefficient, thus most of the best stocks won’t use them. Requiring stocks to pay dividends would have meant missing out on AMZN, GOOG, FB, NFLX, TSLA, for a whole decade and counting. And today you’d be adding to that list many other names that are growth stories of the next decade.

There is nothing bad about dividends, but it is a very poor portfolio selection criterium because it implicitly excludes a large portion of the market with the best growth opportunities (by construction).

Focus on income if you need the income *now*. In any other case the only thing that matters is total return, and it is a mathematical fact. It is even more true in a tax shielded account, where switching allocation does not incur a capital gain tax.

P.s. I own several stocks for their dividends, it is a perfectly reasonable reason to own them; just do not expect them to give you alpha.

[usiah]

The rock and sand story was told by Jesus centuries ago:

"Therefore everyone who hears these words of Mine, and acts upon them, may be compared to a wise man who built his house upon a rock. And the rain descended, and the floods came, and the winds blew, and burst against that house; and yet it did not fall, for it had been founded upon a rock. And everyone who hears these words of Mine, and does not act upon them, will be like a foolish man, who built his house upon the sand. And the rain descended, and the floods came, and the winds blew, and burst against that house; and it fell, and great was its fall." [Matthew 7:24-27]

[Rida Morwa]

@usiah Very true it finds its origins among the pages of the Bible.

[usiah]

@Rida Morwa

Yes, specifically, with Jesus Christ Himself.

[Buyandhold 2012]

Why income?

Because the grocer will not accept a smile as payment.

You need income to pay the bills.

And the bills keep on going up.

So your income needs to keep on going up.

A friend of mine just retired at age 75. He phoned me today telling me that he's worried he might run out of money before he turns 90.

"Don't worry about it," I told him. "If you go broke, you can always move in to one of my spare bedrooms."

"That's not funny," he said. "I'm down to my last 2 million dollars because of required minimum distributions."

"Look on the bright side. You might kick the bucket before you turn 90."

"I should have kept my job until I was at least 80."

"Better yet, work until they carry you out on a stretcher."

I think I'll ask my mother to call him.

She keeps telling me that she could live on 20 bucks a day.

And she probably could. She should write a book.

The bottom line is that a portfolio of high quality dividend paying stocks generates an income of about 3% a year.

So do the math.

If you need an extra $30,000 a year when you retire, you need a portfolio worth one million dollars.

If you need an extra $150,000 a year when you retire, you need a portfolio worth five million dollars.

It isn't rocket science.

[Rida Morwa]

@Buyandhold 2012 Thank you for sharing your thoughts! Let him know about HDO, we can make that $2 million stretch his lifetime

[Mozman]

@Buyandhold 2012

what a nightmare. 2 million not close to enough with his time horizon.

[bull_rider]

@Buyandhold 2012 And one can easily get more then 3% divs. Plenty of industries (energy, pharmaceuticals, grocery stores to name a few) pay quite a bit better than that, and even if the stock fluctuates during things like the 'covid scare' as most did, the underlying business model is stable and you'll keep getting the divs. I'm getting 7.13% on my investments presently and I'm not just chasing dividends - Rida has given me some great ideas for industries and stocks to buy into.

[BM Cashflow Detective]

How was wealth created originally?

The best question ever.

Quite simply through constant accumulation.

Something for hunters and gatherers.

Nowadays called investors. ;-)

Accumulation is a stylistic device of rhetoric and can be identified in texts of all kinds and literary genres. The accumulation describes the ranking of several terms to form a generic term that is not mentioned or mentioned, which makes it more detailed and reinforced.

In the economy and on the stock exchange especially the accumulation of capital, means of production and wealth. ... and of course dividends too.

It is my passion and conviction to hunt and collect stocks as well as owning excess wealth well beyond my needs.

A healthy greed for wealth-increasing accumulation.

Personal responsibility is in my DNA and being rich is my right as a free and independently thinking citizen.

Decisions are not based on possibilities, possibilities are created through decisions.

Think in terms of solutions and create clarity in your life.

[Rida Morwa]

@BM Cashflow Detective Thank you for sharing your thoughts and reading our article.

[Overfished]

@BM Cashflow Detective "Think in terms of solutions and create clarity in your life."

I've run a business for 32 years that's been a one-man show.

I learned very quickly that if I didn't think in terms of solutions that I was the problem.

Re-read the quote because it is very profound and yet one that could easily be passed over while doing our daily reading

@rida
I really appreciate the articles that you produce.
The articles that don't have any specific recommendation usually are the ones that leave me with the deepest thought; the result is due diligence not specifically focused towards my portfolio but towards my entire life ; present and future

Your thought-provoking articles have changed my life and allow me to see a future that includes retirement before I reach 60 years old.

I use the income method personalized to my individual needs

Thanks your efforts 🎁

Fish

[Rida Morwa]

@Overfished Thank you for your kind note! I'm glad we've helped change your outlook and I'm proud to be part of that process.

[RASN]

Outstanding article, Rida! And yes, I sang that song as a child; my grandchildren know it now and it's sound advice - for income, for life and for eternity. I've been working with several of my clients to recognize that the prospect of rising interest rates that has "taken the shine off" a few investments made earlier this year is actually an opportunity, not an obstacle, to an income investor. Writing to one this morning I commented that DCA'ing is the friend of an income investor even more so than a growth investor because the higher income starts the next quarter - and continues - while, for a growth investor, he has to wait for Mr. Market to, someday; hopefully, reward the added investment. Thanks for the great column.

[Rida Morwa]

@RASN Thank you for your kind comment! I agree it is applicable to many important aspects of life.

[PendragonY]

@RASN
I find it far easier to predict dividends than share prices. After all, dividends are determined by about a dozen people who coordinate their actions, while share prices are determined by thousands to millions of people who by law are restricted in how much they can coordinate.

[racerkeith]

@PendragonY Well stated Sir!

[dean3084]

Thanks Rida. Great article per usual. Your analysis is spot on, as my approach to high dividends is 7% or greater which I own over 40 at this time. Being 77 years old I may differ from others as my main objective is preservation. If I can collect 7% or better and at least maintain my cost basis and inflation I'm a happy camper. Capital gains are a bonus. I'm curious if I'm on the right path. Dean3084

[ron2004]

@dean3084
I too enjoy reading Rida.
You are 77. You state (conceptually) how you are investing but at the end you state: ". . . I'm curious if I'm on the right path". IMHO, that's a curious thing to say. Why, are you not sure or confident in your own investments?
NO ONE's investment strategy is or can be perfect. Investments may require change over time.
Oh, BTW, I'm 73 and my portfolio is working fine for me.

[PendragonY]

@dean3084

Looks like a good path to me. Rather than just looking at yield, you need to make sure your holdings can continue to pay the cash dividend they are now paying, and over time increase it some as well. But otherwise, you look to be doing great.

[Rida Morwa]

@dean3084 To me, it sounds like you're on the right track. I personally do not like owning anything that yields less than 6% as a general rule of thumb, occasionally I do if the opportunity is stellar.

[alligatorjim]

Sage advice..........

[Rida Morwa]

@alligatorjim Thank you

[clintonc]

The dividends earned the first full month paid for my yearly subscription. And. Has produced the same amount or more every month since. You talk about “recreated” or “ rediscovered”. When I read your thoughts on investing it was “revolutionary”. So happy I joined and looking forward to a long and profitable partnership. Can’t think you and your team enough.

[PendragonY]

@clintonc

Until fairly recently the way to amass wealth was to have assets that generated a good income. Selling assets to cover expenses was seen as the path to ruin. So yes, this is not new even if it has been out of vogue recently.

[Rida Morwa]

@clintonc I'm glad you're seeing such great success. Thank you for being part of our HDO family!

[Phil in OKC]

@PendragonY Another way of saying that is this: “The more you handle your bar of soap, the smaller it gets.”

[gort9999]

Rida, thank you for your guidance, information, and wisdom. Dividends are like money falling out of trees. And, with dividend reinvesting, compounding dividends are one of the greatest wonders of the world. Start dividend reinvestment early, and sit back and watch your wealth grow over time.

[Rida Morwa]

@gort9999 You are very welcome! I agree the longer you have to build your income in-flow the better

[bull_rider]

@Rida Morwa When I was 25 my employer's company changed hands and they closed out my 401k and sent me a check. At the time I was strapped for cash and the money did not get re-invested. Had I put it into investments earning 10%, between then and age 65 I'd have seen that $10,000 grow to nearly a half million.

[PendragonY]

Buy assets that pay you to own them. It's a very old way to gain wealth. And it still works today.

[Rida Morwa]

@PendragonY Agreed!

[racerkeith]

@PendragonY taking advantage of compounding!

[Hook looker]

Excellent perspective. It works

[Rida Morwa]

@Lance g Thank you, I agree it truly does.

[billinsd]

APPRECIATE YOUR WORK RIDA...

[Sane Man]

@billinsd As a retiree, I have been using some components of the income method and have been buying bit by bit on some of the recent CEF dips. Though with the recent volatility, my accounts are down on average 6% since August. That’s because much of the market has been in a quasi correction for a few months —-and that’s across all asset classes! But at this month’s end and on November 1st I will receive most of my monthly distributions , which

now will be 16% higher than the previous month because I’ve been in buy mode and I’m dripping everything, which guarantees me a raise every month unless a distribution is cut. That 16% will be part of my ordinary everyday money used for personal expenses such as dining, boozing , shopping etc.
Admittedly, it does hurt to see my “net worth” or principal down because it is a six-figure sum. But I don’t plan on using that money-yet. However, due to the income it’s providing me, I AM using that money !! At 63, I don’t collect SS yet, but I am considering it shortly. My break even point if taken now is 80——and if I need that extra 10,000 a year at 81 the experts say I’m screwing myself for by not waiting til 70 , so be it. That would mean something terribly would have gone wrong investing in the next 17 years. I want to travel more and enjoy my vacation home more while I can——SS is not money in the bank like some claim it to be and you can’t pass it to heirs—-so use it for longer with less while you can.

[Rida Morwa]

@billinsd You are very welcome!

[Phil in OKC]

@Sane Man You can pass on your SS to your spouse, if it is a higher amount