Dividend growth stocks growing coins

Reasons to love dividend growth stocks and dividend growth investing

Why you should love investing and dividend investing

There are many reasons that you might love dividend growth stocks and funds that pay distributions. These reasons are not true for everyone, and many dividend growth investors will have a different perspective. And, yes, this requires a balanced article on drawbacks – a post that will come at a later date. So here are five reasons that you should love investing and dividend investing ­čÖé

Dividend growth stocks growing coins
Dividend growth stocks growing money over time

Cash flow and gaining distributions from companies and funds is a core part of my overall portfolio strategy. There are other important elements, as well, such as safety and security. The money that I invest is important to my family. Note that this is not money we need or may need tomorrow (we do have an emergency fund, as many wise people advise!) but it is important to help provide the type of life and lifestyle that we aspire to in the future. As such, we do not ‘gamble’ or make reckless decisions with the money we have. Instead, we invest in a way that some would say is borderline ‘boring’ but which helps us to reduce risks and feel comfortable with our positions.

1. Cashflow and income with dividend growth investing

Right – I mean, who doesn’t like income? It is a core focus for almost every dividend growth investor I know. While regular diversified funds (e.g., VOO) only pay a small percentage in dividends, a portfolio of cash-flow-oriented stocks can return three or four times this level of dividends and take on similar characteristics to a broad index. As such, if you get a similar outcome in terms of growth, why not take the income?

Income is wonderful. You can use the money flowing in to pay bills. Or take a holiday. Or enjoy some relaxing meals out with your loved ones. The benefits for the dividend growth investor are not to be ignored!

Dividend growth investor cash
Dividend growth investor – able to create more cash

Not all long-term investments are good at generating income in this way. Some of the ‘aristocrats’ or ‘kings’ in this space (those paying consecutively growing dividends for 25 or 50 years, respectively), only have small yields. Some also have very low growth rates in both their core business activities (growing income slowly) as well as the distributions to shareholders (with low DGRs). Others also trade at premiums, due to their historic stability and security offered by the business. But where I have been investing in world-class companies, buying them at good values with a margin of safety, I can be fairly certain that I will be increasing my future cash flows and income. And, best of all, world-class firms also tend to increase the amount of the dividend over time, at a rate that usually is over the general inflation rate. This is, by far, the easiest pay raise I ever get!

Overall, however, the income from these stocks is important to me and my family. And I can be sure that over time the amount of income will continue to increase. Year after year. Decade after decade. One day, I hope, my children will inherit some of these shares and continue to benefit.

2. The feel-good factor where cash flow makes you feel great

While investing is inherently technically focused on risks and returns, there is also a large emotional component. You need to sleep well at night and enjoy life. You need to be comfortable with the investments. Cashflow can provide this and also provide a feeling of having a safety net.

Investing and dividend investing

Investing is inherently mathematical (rates or return, compound annual growth rates, etc.) and yet it is also an emotional factor. I believe it becomes increasingly emotional when it is family wealth that is accumulating, as you want to do the best for your own future as well as your dependents. In this case, investments may be focused less on mathematical perfection and somewhat, at least, on what is emotionally acceptable or what ‘feels good’ in a way that helps you to sleep at night and not panic, worry, or bite your nails with concern.

It sounds silly, but the simple little pleasure of seeing money flowing in invariably puts a smile on my face. I also have income from royalties (annual payments relating to my authorship of books) that flow in from time-to-time, but it is much less frequent and is not as reliable as distributions from world-class firms that continue to grow and profit.

The on-going flow of income provides a feeling of security and safety, even if it is not the most mathematically optimal way to invest. And that feeling of security and safety is important for me and my family.

3. Tangible returns you do not need to time if you are a dividend growth investor

You do not need to time the sale of assets to capture this cash flow if you are a happy dividend growth investor. You do not need to sell off stocks in a bear market to cover your expenses. A good portfolio of dividend stocks will keep the cash flow coming. No guessing is required about when to sell assets. The work is done for you. If you have invested in a good company, you could assume that the management team would not jeopardize the future success of the company by providing over-sized distributions to shareholders. (Note – not always true, but if you focus on firms that have paid dividends through thick and thin, it is likely true that the dividends are safe and reliable and not detrimental to the firm.)

Mathematically, it is optimal to simply sell shares or holdings at times to release capital in retirement. However, as much as investing is a mathematical game, it is also an emotional game. In this situation, a dividend growth investor can feel re-assured that they are not selling shares at a bad time to create income, as their distributions come flowing in regular income.  It is a double-edged sword, as the company managers force this income on us with the distribution at a time of their selection. It may not be when we want it. (Note, however, that a careful portfolio design with US-based stocks will enable us to spread the quarterly distributions to different weeks or months over the year, giving us some spread of income although it will still remain lumpy and sporadic.)

By taking money from my investments in the form of a distribution rather than electing to sell some of the holdings, I can remove one decision. Removing decisions can be a blessing as I never need to worry whether as a dividend growth investor I have made a poor choice; I can just take the distributions and income and be happy. There is no emotion attached to a sale of a holding as I have the distribution coming. I do not need to concern myself with second-guessing myself about the sale as I have the income coming.

4. Opportunity to re-invest at lower prices during drawdowns and improve yield

A correction or a bear market? GREAT – this means that a dividend growth investor can put the dividends to work buying the best companies at lower prices. This improves the yield of my investments and allows me to purchase more future cash flow at a better rate. You might have the DRIP (dividend reinvestment on autopilot) turned on, or you might collect the dividends and allocate them manually to the best possible assets to buy.

I know that many investors have a DRIP turned on. I’ve personally not used the approach, but instead I tend to collect the distributions and income and then re-invest it carefully in what I think is the best possible option at that point in time. In this way, even if the market is healthy, I can select which stocks give me the most upside or margin of safety, and then select these for investments. As it is a “market of stocks” rather than a homogeneous ‘stock market’, there are always many opportunities on offer.

During severe downturns, if the stock has declined by 50%, then the same number of dollars invested now will buy twice the future cashflow as it would before the decline. That can be powerful. As a consequence, I welcome downturns and corrections. I do not like seeing declines in the value of my holdings, but the opportunity to buy more holdings at a lower price excites me. I buy more income at the present time. Note that this attitude is most closely correlated to investments in QUALITY companies that I am sure will be there for the long-term, driving ever-increasing levels of value for me.

In even more extreme cases, if there was a ‘lost decade’ where the economic growth slowed, company earnings growth slows, and stock prices decline slowly or go no-where fast (or go side-ways), then this is also valuable. I can invest the distributions and income into more income-growing assets, even at the same price. This still enables me to grow and develop my future income potential. Because of these reasons, I believe it is important to keep a close eye on the wider macro environment to understand what considerations and factors may influence particular stocks.

dividend growth stock macro environment
dividend growth stock considerations will also include issues in the macro environment

5. Off-sets or mitigates drawdowns when you buy dividend growth stocks

I have put this one last as it is not that important nor significant when considering dividend growth investing. If the stock is down 30 or 40% in the year, having a 4% dividend yield hardly compensates for a dividend growth investor … but it does provide a small mitigation factor that may help you sleep better at night. If you have bought a solid company at a fair price (think: value investing) then you may avoid such significant drawdowns.

If the market falls for 20% and your holdings fall that much as well, if you bring in a ‘guaranteed income’ from the stocks/funds in the form of distributions, then this income off-sets your loss, a little. Clearly, it will fail to perfectly offset any but the most mild market reaction, but it can be proportionally powerful; in this case, even with a market decline of 20%, a 5% yield reduces the decline by a quarter. Yes, I will take that!

There is also evidence that many firms with a long-standing commitment to paying dividends have greater stability and security. The very fact that they continue to pay dividends and have been increasing them for decades will usually ensure that the senior management team has a commitment to doing this in the future and structure their business to help ride out rough patches and continue to enable them to pay out to their shareholders.

Why you should love investing and dividend investing There are many reasons that you might love dividend growth stocks and funds that pay distributions. These reasons are not true for everyone, and many dividend growth investors will have a different perspective. And, yes, this requires a balanced article on drawbacks – a post that will…

Why you should love investing and dividend investing There are many reasons that you might love dividend growth stocks and funds that pay distributions. These reasons are not true for everyone, and many dividend growth investors will have a different perspective. And, yes, this requires a balanced article on drawbacks – a post that will…

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