- We need to take a moment to look at 3 brutal truths, so you have a clearer perspective.
- Income investing will revolutionize your retirement portfolio, but there will be many skeptics.
- Every journey with great rewards has truths you must understand as you travel it.
- Looking for a portfolio of ideas like this one? Members of High Dividend Opportunities get exclusive access to our model portfolio. Learn More »
Co-produced with Treading Softly
Have you ever had news to share and wanted to find a way to soften its hard-hitting nature? I'm not talking about spin-doctoring it to make bad news into good news, but I'm talking about the desire to ease the potential damage from a hard-hitting truth out of concern or love for another.
Sometimes our family or friends will encourage us to "tell it straight", meaning no softening, no dilution, no spin, just the hard truths. I enjoy getting the truth straight out, letting the impact take its toll. Although I often am tempted to soften the blows for my children, I resist the urge to do so. All truth without love can be brutal. All love without truth is substanceless.
So today, I want to shoot it to you straight with some brutal truths about income investing. Today we need to look at stark reality, so we know what we are doing with a clear mindedness that often we do not naturally possess.
Brutal Truth #1: You Will Face A Dividend Cut
The biggest flaw we have when it comes to income investing is thinking we will magically avoid all dividend cuts. Some investors believe this will be the case by only buying "blue chip" companies, "dividend aristocrats", "dividend champions", "SWANs", or another fancy name someone slaps onto dividend stocks. Sadly, many investors get blindsided and taken off guard.
When Kraft Heinz (KHC) cut its dividend, many were caught off guard. After all, it was a company that Warren Buffett held (and still holds) and, until 2019, had a history of raising its dividend annually.
The Great Financial Crisis helped reveal how fragile the dividend aristocrats list was. It looked heavily different, as 40% of the 2008 members were cut from the list within five years following the market crash. No matter how long of a history a company has of dividend raises, no company is immune from a cut.
The simple truth is this: You will face a dividend cut.
It's not if you will but when, and when it happens, you need to be prepared to decide what to do. Some companies cut their dividend due to financial duress like KHC. Others like Lumen Technologies (LUMN) cut their dividend because the CEO and Board of Directors do not feel they're getting enough credit from the market for their high yield. Some might cut as part of restructuring the company for a stronger future like Antero Midstream (AM).
You must stay on top of your portfolio and remain informed on the financial health and outlook of the companies you invest in for income. No matter how old or established, any company can cut its dividend in a time of need. CEOs are the ultimate salesmen or saleswomen for their company, so don't blindly take their word on the matter. Do your own due diligence and determine if the dividend cut might be a positive for the company.
Brutal Truth #2: Dividend Growth Lags High Yield For Income Generation
This one I know will ruffle a few feathers. I often get asked, "Why not just buy a growing dividend instead of a high yield?" This is often asked with the implicit assumption that a growing dividend is innately "safer".
There are two issues at hand here:
- A growing dividend often has a low yield.
- Dividend growth expectations are not guaranteed to occur.
If we have a 5% yield growing at 5% annually, how long does it take it to match a 9% yield that's unchanging?:
It would take 13 years for the income to be comparable. And that is just to start receiving the same income on an annual basis. Since the high yield was paying higher all along, that is a lot of income to catch up on.
The dividend growth strategy would generate $88,530 of income vs. $117,000 from the high-yield strategy. By focusing on dividend growth, this investor loses out on over $28k worth of income over 13 years. According to the U.S. census bureau, the average retirement is only 18 years.
How long does that take for dividend growth to catch up? An additional ten years!
This rough model fails to account for the time value of money. Cash right now is far more valuable than cash in 10-20 years. It also assumes no reinvestment, dividend cuts, or changes in dividend growth. For a dividend growth stock, the failure to increase the dividend can be every bit as damaging as a dividend cut since investors are including expected dividend growth into their valuations.
The brutal truth is that while "delayed gratification" is often better for investing, delaying income is not your friend if you don't live to see it. A bird in the hand is worth two in the bush. Get your income now and enjoy it.
It often seems like dividend growth is promoted by those who expect this mythical benefit from growing dividends. Yet, they forget the first brutal truth, that any dividend can be cut at any time. So just because it was growing for years, often at a plodding rate, it doesn't stop it from being cut. KHC grew the dividend right up until they cut it. Dividends aren't guaranteed until they are deposited into your brokerage account.
Brutal Truth #3: Friends Will Be Skeptical
If you had teens in the '90s, you might remember they loved a song by Greenday called "Boulevard of Broken Dreams" one refrain from that song was:
I walk this empty street
On the Boulevard of Broken Dreams
Where the city sleeps
And I'm the only one, and I walk alone "
While it wasn't and isn't my jam, income investing can often feel like a lonely battle for individual investors. The news cycle focuses on the big wins more often than the big losses of day traders and meme stocks. It can create the sense that you are "missing out" if you aren't up 80% in the past month. Big names like to ignore dividend investing or, out of hand, reject high yields as "dangerous" and "overly risky". We see it in our comment section. Income investing is often maligned and pushed to the side by others.
If you tell a friend you're getting 8% yields from a great company - they may scoff at you. I frequently get one of two responses:
- The capital gains are so small. I'm up X% in TNBT (TheNextBigThing), it's going to be worth trillions!
- OMG, 8% is SOOOOO risky! I'm buying LYDA (LowYieldingDividendAristocrat), it is yielding 1.5% with 10% annual dividend growth!
One of the things I stress with the Income Method is focusing on the income. Share prices are volatile, and they change every single day. While your friends are panicking about COVID, Delta, Omicron, the next financial crisis, the next big bust, and how 50% of their retirement is wiped out in the next bear market, you won't panic.
Why? Because you've spent your time growing your income a dividend at a time. Your dividends come in several times a month, providing you cash to buy the market crashes, pay your bills, and a cushion besides. Whether the market is up or down, there are places you can go to grow your dividends and keep your head while those about you are losing theirs.
- Source: Shutterstock
Today, we looked at three brutal truths about income investing. We often talk about the positive aspects - there are so many! Today, we wanted to shed some light on less covered aspects.
Income investing can and will revolutionize your retirement, it will make it easier to afford your daily life and new experiences, reduce financial stressors and unlock so much potential from your portfolio.
Yet you need to be aware that you will face a dividend cut at some point in your investing career, so don't bank all your success on never having one.
You shouldn't forego strong income now hoping that dividend growth will continue indefinitely. The "Dividend Aristocrats" index only holds 64 names. It is very hard and rare for a company to sustain dividend growth for 25+ years. Unfortunately, that is the type of time frame that many "dividend growth" investors rely on for their picks to grow.
You will also face many skeptics who doubt your methods while hoping to hit it rich on a single stock pick.
Retirement is a time to kick back and relax while enjoying the fruit of your labors. We must also have a clear and unhindered understanding of our journey in the market. Complete understanding allows enjoying our retirement thoroughly!
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This article was written by
Rida Morwa is a former investment and commercial Banker, with over 35 years of experience. He has been advising individual and institutional clients on high-yield investment strategies since 1991.Rida Morwa leads the investing group Learn More.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of AM either through stock ownership, options, or other derivatives. 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.
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