Is Dividend Growth Investing worth it?

Before you start Investing

Before considering Dividend Growth investing or investing in stock markets, it is generally a good idea to have a look at your current financial position and how that might look in the future. Factors that are worth considering are

1. How Sustainable your Income is?
2. What is your savings rate or can you even afford to save?
3. Do you have a mortgage and is it worth paying this down first?
4. Do you have any other debt or have you an emergency fund??
5. What are your actual retirement goals?.
   

Job Sustainability

Let us be honest, some jobs are more sustainable than others, so it is important to assess your income before making any investment decisions. If you have a part time or seasonal job than it may be more important to work on improving this first.

You should only invest what you can afford and if you can’t afford to be saving at least 5% of your income than the chances you can afford to invest is pretty slim. The last thing you want to do is sell your assets if you hit a bump in the road down the line.

Is your home an asset?

Is your home an asset or a liability. My view is that if a mortgage is involved and there are monthly repayments leaving your bank account each month than your home will be a liability. It will only become an asset when it is completely paid off and no longer draining your funds.It makes complete sense to pay down your mortgage before committing yourself to the stock market. Particularly at the beginning of the Mortgage where the bulk of your payment is on the interest portion of the loan.

However, there are times when it will make sense to invest in the markets instead of overpaying your mortgage. The long term returns of equities have delivered up to 10% before Tax. At the time of writing the average European Mortgage interest rate is 1.4%. By Paying down your loan you are saving this 1.4% which gives you a pre-tax return of 2.8%. Even with a 50% tax rate on equities you can still nearly double your return by investing in the stock market.

When to Invest your money?

Investing in the stock market should only be done with surplus savings. Using debt to fund your Investments can be tempting but it also increases the risk. A simple example of this is to look at the booming property market in Ireland during the Celtic Tiger. Investors borrowed for overvalued assets without understanding the risks and ended up in a position of losing these investment houses.

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Why Dividend Growth Investing?

First, let me say that there are many different ways to invest your hard earned money depending on your goals and risk level. A common way to mitigate risk is to diversify your investments. By Asset class and or by geography. I always recommend writing down your investment goals and risk level to help with choosing an investment strategy based on your goals.

For example, In Ireland, property might be the quickest way to increase your net worth but as mentioned in the earlier paragraph this comes with leveraging debt and hence could be more risky.
For me, Dividend growth Investing is not a get quick rich scheme. Rather it follows the power of compounding to help you reach Financial freedom over time.
Albert Einstein was quoted as saying that compounding is the 8th wonder of the world. And guess what… he is correct! For compounding to be effective you need to consider both the rate of return and time.

To illustrate this point, Take a €10k initial investment where you don’t add another cent for 20 years. At a 5% return you will have just over €26k. At 10% you would be forgiven if you expected to have €52. However you would have €67k at the end of 20 years. Now imagine if you started with 100k of even 1 million!

But the Question Remains…Why Dividend Growth Investing?

Dividend growth investing has historically provided very good returns

Dividends have played a significant role in the returns investors have received during the past 50 years. Going back to 1970, 78% of the total return of the S&P 500 Index can be attributed to reinvested dividends and the power of compounding, as illustrated in FIGURE 2.

If you analyze the S&P 500 from 1960-2017, the dividends have grown on average 3.01% per year for the index. To put that into context, if you invested $1000 in 1960 you would have an annual dividend payment of $34.10. Without putting another dollar into your investment and assuming that you withdraw your annual dividends, in 2017 you would receive an annual dividend of $855. Furthermore, your initial $1000 investment would be worth $46,000. Does that sound a lot? If not, try the same calculations with an initial 100K investment instead of 1k.  

This could be further enhanced, if instead of withdrawing the yearly dividend that it was reinvested into the index. The original $1000 investment would have bought 17 shares with a $34.10 dividend in 1960. In 2017, the same investment would now have 93 shares with an annual dividend of over $4000 and the investment would be worth over $250k.  

Dividend growth investing is tangible.

Remember companies are not obliged to pay shareholders a dividend. There is an Argument that a company might be better to reinvest money back into the company to help them grow further. As they do this the share price increases and hence a shareholder net worth increases also. But this is just paper wealth.

Share prices can and do fluctuate. Just look back to the last financial crash. Dividends come straight from business operations back to the investor. It is the transfer of wealth from the company to its shareholders. This money will actually hit your account, you can see it and spend it as you please. I like to view this as partially realizing my gains.

I can re-invest in the company if I chose but the option is mine. Even when share prices fluctuate there are companies such as the dividend aristocrats who continued to pay and increase the dividend each year. Some have even continued to raise the dividend through multiple recessions.

There is a place for both growth and dividend companies in any portfolio but for me, the psychology of receiving this dividend is far more relaxing than worrying if I have to sell a company at the worst possible time

It makes the investor excited when the market falls.

I touched on this a little above. When you only have paper wealth, your wealth is directly connected to the fluctuations of the market. This can be an emotional rollercoaster where you could see your wealth diminish by nearly 25% in one week like in the “Crash of 2008”. Think about that for a moment. you have €1 million in your account coming up to retirement and in one week it drops by €250,000. Could you stomach this?
Now before you say it! Dividend Growth Stocks also fluctuate with the market. However, I am not investing in Dividend Growth Stocks purely for a rapid rise in the share price. According to Intelligent Income by simply safe dividends, History has shown us that over the last 11 recession the average decline in S&P 500 companies was -31.8% while the average decline in S&P dividend companies was -1.9%

My goal is to invest for income and for my dividend income to exceed my expenses. I don’t care about the daily fluctuations of price. I only care if my companies can continue to support my income. Companies in the dividend Kings and Dividend Aristocrat lists will have survived multiple recessions while continuing to increase yearly. When the market drops it actually presents a chance to get some of these companies at an attractive price while still collecting dividends.
Instead of fearing the market dropping, Dividend growth investors in the accumulation stage actually welcome these market crashes such as the recent drop in March due to COVID-19.

Don’t have to sell stocks in retirement

I mentioned paper wealth above and it is great to see €1 million in your account. But what happens when it comes to retirement and you need to live from your wealth. You now need to sell some stocks to generate income. Those of you who are chasing FI will no doubt have heard of the 4% rule. If you haven’t then I highly recommend this blog post by Paddy Delaney over at informed decisions. What happens if you were to retire just when the market crashes. your calculations might not work or worse still you might have to sell stocks at the worst time just for income.

With dividend stocks, Unless the company cuts the dividend then you will still receive income without the need to actually sell the stocks. If the market crashes, yes there might be a chance of dividend cuts but if you have a well-diversified portfolio you can ignore most of the noise.

The Wall Street Journal has a good article on how dividends can help fuel a healthy and sustainable retirement. The article assumed you retire with $1 million and desire $40,000 in annual inflation-adjusted retirement income. It also assumed that inflation runs at 2%, Treasury yields match the inflation rate, and stock dividends grow 3.5% per year.

It would be negligent of me if I did not point out that going all in on dividend stocks in retirement is risky. I would suggest to not completely rely on one asset class of investment style in retirement. Instead chose a well balance portfolio that will help you smooth out any bumps you may have in retirement.

Get a yearly raise of over 10%

With a dividend growth investing strategy, you will typically be investing in companies that will continue to increase the dividend each and every year. It is not uncommon to be raised by 10% or more. In fact, Aflac recently announced a 17% raise here! Could you imagine getting a 17% raise from your workplace? Unless you work for yourself, it is unlikely that you will see raises this high too often. The best part of these raises is that you do not have extra responsibility or have to do any extra work to receive them.

Conclusion

Investing in companies with sustainable dividend growth can help to increase total return, reduce volatility while providing a steady income stream. Companies with strong balance sheets and good fundamentals provide the foundations to continue to increase dividends even in your retirement.

Like all investments, there are risks such as a dividend cut of a company going bust. But a well-designed portfolio will not just rely on one asset class or investment style. Once you understand the risks that investing in a dividend growth-oriented stocks is completely worth it in a properly diversified portfolio.

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Disclaimer - Engineer my Freedom is not a licensed or registered investment adviser or broker/dealer. We are not providing you with individual investment advice on this site. Please consult with a licensed investment professional before you invest your money. This site is for entertainment, informational, and educational use only. Any opinion expressed on the site here and elsewhere on the internet is not a form of investment advice provided to you. We use information, data, and sources in the articles we believe to be correct at the time of writing them, but there is no guarantee of their accuracy, completeness, timeliness, or correctness. We are not liable for any losses suffered by any party because of information published on this site or elsewhere on the internet. Past performance is not a guarantee of future performance. By reading this site or subscribing to it, you agree that you are solely responsible for making investment decisions in connection with your funds.