My general investing philosophy is dividend growth investing. I have a multitude of reasons for this, some of which include
- Creating a growing income stream to live off eventually
- Having an income stream grow over time, at most times at rates greater than inflation
- Not wanting to sell assets in retirement
- Not being so intimately tied to the stock price to make money
- Being able to tune out the day to day noise in the markets
- Being able to buy (and sell) opportunistically
- Sleeping well at night!
- Bonus point: Being able to leave a nest egg for my kids to follow in my footsteps, hopefully
The power of dividend growth investing comes from what I call the three-headed monster or a three-legged stool:
- New purchases bring more income.
- Reinvested dividends generate their own income.
- Buying companies with yearly dividend raises generate even more income.
Over the long term, dividend growers have beaten the market by a drastic amount. I fully expect this to continue to be true in the future.
Creating a Growing Income Stream
The first three of my bullet points are all related. The main driver of my investing decisions is that I know my working days are ultimately limited. Needing money for future expenses an unavoidable fact. I am spending my working years investing in quality companies with a vested interest in rewarding their shareholders. By investing in quality companies, they will grow my income over time instead of a fixed yield instrument in aggregate. Often – in fact – most of the time, the income stream should grow in real terms, that is, greater than inflation. In short, I should become wealthier over time!
I wish to hold on to my money-generating assets during retirement. The common path has been to sell 4% of assets per year though that is evolving. As we have seen since the Great Recession, the future is very unpredictable. Current retirees are hurting for yield; stock prices overall are quite high, yields on treasuries and bonds are at historic lows, and social security increases have been next to non-existent. The current baby boomers may be forced asset sellers to pay for general living expenses. It only stands to reason to hang on to the money-generating assets and living off the income payments.
Ignoring The Noise
With no dividend yield, you have to pick your entry and exit points carefully. You need to be right on both sides of the trade to lock in a profit. Otherwise, it is merely paper gains and losses. Following dividend growth investing, I don’t care what happens with day-to-day prices because my income is unchanged at the end of any given day. Over time I don’t care about the market volatility; my income next year will be higher than my income this year.
I also don’t need to try to be right on both the buy and sell-side of a trade to make money; I am continually getting a return from the quality companies I am invested in. Also, as it is true that trees don’t grow to the sky, yields don’t grow to the sky. That is, for good dividend-paying companies, prices will follow the growing dividend. All things being equal, if a dividend grows 10%, the stock price should grow 10%.
The last bullet point from that trio was about being opportunistic. The importance of that statement can not be understated. Since I am continually getting a reasonable return, I can buy and sell opportunistically. Part of my philosophy is selling if the valuation has become completely uncoupled with reality. Conversely, buying a stock when I perceive it to be undervalued gives me an additional margin of safety and the potential for future market-beating returns.
The last two points are valuable to me. Nobody wants to stay awake worried at night because they don’t know if their big bet on a small pharmaceutical will pay off or not. By and large, the companies in my portfolio are large-cap, dividend payers with varied histories of increasing their dividends.
If all goes well, I’ll be able to live off the income generated while the underlying assets continue to grow. It would mean the world to me to leave my kids with a portfolio that they could continue to benefit from and hopefully pass on to their kids as well, and so on.
My Definition of Dividend Growth
An important caveat I will make is that my definition of dividend growth may be broader than current retirees. I won’t hesitate to sell a stock if the situation warrants it. For example, a dividend cut, drastic overvaluation, or capital might be better invested in another idea.
Additionally, I do hold some current non-dividend payers. Companies like Google, for example, I expect down the road to start paying dividends. For a non-dividend payer, valuation is still of paramount importance. Overpaying for any stock will limit your future total returns. I also have a few companies with low current payouts that I expect to grow drastically over the next decade.
This segues into the other investment opportunities that I will pursue from time to time.
I am open to “long tail” investment ideas that may not appear immediate literal dividends. I define long-tail as themes or investing trends that may take time to play out, the winners are not guaranteed, but it seems to be where trends are moving to. Ideas as broad as the future of money, electric (EV) or self-driving cars, and even controversial topics like marijuana.
Some of the tactics deployed here are quite different from typical fundamental valuations used for dividend stocks. The future is always murky, and no winners are pre-declared. One tactic I am employing is using a basket approach to a particular investing theme. For example, I may buy equal-weighted shares of 4-5 companies in a particular field to try and gain broad exposure to said theme.