Here is the simple answer: live off dividends
Here is the longer answer –when you live off the income that your portfolio produces, the chance that you will ever run out of money is greatly reduced. If you have to sell portions of your portfolio and thus rely on finding someone else to sell at higher prices than you bought, then you have a higher chance of outliving your money.
It is very easy to monetize a pile of cash, and convert it into a neat dividend machine, which will deposit cold hard cash into your brokerage account regularly. You can then use that cash to either spend or to reinvest into more dividend paying stocks, paying even more cash.
As I discussed earlier, there are largely two types of dividend growth investor investors. The first group are those who have been putting money mostly in dividend growth stocks regularly, reinvested dividends, and maintained their portfolios. The second group include those who are trying to convert a nest egg accumulated over a lifetime of hard work, or an inheritance or another pile of cash received recently as a lump-sum. Those are the ones who want to learn how to pensionize their assets, and live off that pile, while also minimizing the risk of loss to the minimum.
If you are building a dividend growth portfolio from scratch, the first step is to start slow. Get a list of dividend growth stocks and identify the leaders in their industries that also have dividend growth streaks. A long streak of regular dividend increases shows a company which is prospering, as evidenced by the higher amounts of cash it sends to shareholders. A company cannot fake cash for long, which is why many investors consider the proof of regularly increasing cash dividends as proof that earnings are increasing and business is good. It is also important to understand which stage of dividend growth the company is. You are mostly interested in companies that manage to increase dividends because their earnings improved over time. When earnings and dividend growth go in lockstep, you know you have found a candidate for further research.
If that candidate is available at a good price, then it can find a place in my portfolio. I usually try to avoid paying more than 20 times earnings for a company. I also require adequate dividend growth exceeding 6%/year, rising earnings and dividends, and try to understand if the company can continue its growth. Most often, I have found out that a body in motion, keeps its upward trajectory for years to come, until something changes. When something does change, the company cannot fake cash flow anymore, and they either freeze or cut dividends. I am a very patient investor, and will hold even through long periods of time while a company works its issues out, as long as my payout is at least maintained. I won’t add any more funds to this position, and would monitor it more closely, but would not sell it. If however a company does cut or eliminate distributions, I am out one second after the announcement. I can get back in if they start raise dividends again, and I believe earnings can grow and sustain the streak again. Having an exit plan is as important as having an entry plan.
I also try to build my dividend portfolio stock by stock, in an effort to have a diverse stream of cash coming my way. I do not want to be overly dependent on any single company for my dividend income, or a single sector. The nature of dividend growth stocks means that I own too many consumer staples and energy companies unfortunately. It is also important not to diversify just for the sake of diversification, but genuinely look for companies which you believe will be there in 20 – 30 years, and possibly earn more to pay more in dividend income. If there is a high confidence that a company will be there in 20 – 30 years, that increases the chances that it will be hopefully earning more over those years and rewarding that shareholder with more cash. Those growing dividend payments will protect the dividend income of the investor from the destructive power of inflation.
It is also important to dollar cost average my way into those quality companies. Remember, Rome was not built in one day. Your portfolio should not be built in one day either. When I dollar cost average every month, I put money to compound for me in some of the best businesses in the world today. I ignore noise such as “the market is overvalued and will crash” or “the market has crashed and will crash further” and keep buying through thick and thin. That way I have a psychological advantage, because I will be putting money regularly, while everyone else will be panicking and selling during the next bear market or piling most of their money right when the current/next bull market is about to end. I don’t have to worry about ups and down, and I ignore market fluctuations, because I am investing in real businesses, not some lottery tickets. I also invest for the next 30 years, plan to live on dividends that are derived from earnings, which is why fluctuations today don’t really impact me. What impacts me is only how the business does over those 30 years.
This is essentially what many trust funds and some major foundations have been doing for decades. If you look at the Hershey Foundation or the Kellogg Foundation, you will notice that a large portion of their income comes in the form of stock dividends. Those dividends are spent for charitable purposes. Of course, this has not stopped either Kellogg (K) or Hershey (HSY) from prospering as well. You can also look no further than the descendants of Standard Oil, whose trust fund accounts are filled with shares in Exxon Mobil (XOM), or Chevron (CVX) to name a few, which have been able to raise and pay stable dividends for a century. If those foundations or trust fund babies have been able to live off their portfolios using dividend growth stocks, then why can’t someone ordinary like me live off dividends generated by my portfolio for about 30 – 40 years?
To summarize, I plan on creating a diversified portfolio of dividend growth stocks, by slowly dollar cost averaging my way into attractively valued quality companies over time. By only spending the dividend income, I believe I am being more conservative than investors who sell off portions of their assets in retirement, which dramatically the lowers chances of me running out of money in retirement. In addition, I would not be at the mercy of stock market prices and risk selling when prices are low, but I will be getting cash no matter what stocks do. I will be essentially share in the profits of the enterprise and be essentially paid to hold interest in some of the best businesses in the world.
Full Disclosure: Long K, XOM, CVX
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Monday, January 26, 2015
Here is the simple answer: live off dividends
Friday, January 23, 2015
General Mills, Inc. (GIS) manufactures and markets branded consumer foods in the United States and internationally. This dividend achiever has managed to increase distributions to its shareholders for 11 years in a row.
The most recent dividend increase was in March 2014, when the Board of Directors approved an 8% increase in the quarterly dividend to 41 cents/share.
The company’s largest competitors include Nestle (NSRGY), Kellogg (K) and Danone (DANOY).
Over the past decade this dividend growth stock has delivered an annualized total return of 11.40% to its shareholders. Future returns will be dependent on growth in earnings and dividend yields obtained by shareholders.
The company has managed to deliver a 7.50% average increase in annual EPS over the past decade. General Mills is expected to earn $3.01 per share in 2015 and $3.22 per share in 2016. In comparison, the company earned $2.83/share in 2014.
The company has utilized share buybacks in order to reduce the number of shares outstanding from 818 million in 2005 to 632 million in 2014.
General Mills has a portfolio of strong brands, as well as the scale of operations to make products and sell them efficiently. In addition, the company is trying to maintain an innovative approach and either develop in house or acquire products in growth niches. Consumer tastes tend to slowly evolve over time, which is why companies like General Mills that try to stay innovative and capture major trends in tastes and deliver profits. Continued product innovation is the key to capturing future growth. That being said, the bread and butter of consumer products companies are its established brands, where a large portion of consumers engage in repetitive purchases, that create repetitive cashflows, which make investing in consumer staples such a steady and profitable endeavor. While things do change over time, the change is much slower than that in the technology field, which makes it easier for companies to react, adapt and profit to the changing environment. Having a steady marketing budget also helps to maintain the broad appeal of the company’s products.
Earnings per share could increase from new product offerings, strategic acquisitions, international expansion and streamlining of operations. A constant focus on operations, eliminating unnecessary costs, improving margins and reducing negative effects of input costs are something that should help the company accomplish its targets. The company is able to expand its distribution network on a global basis, invest in innovation and in its strong brands. Having a portfolio of stable food brands generates recurring excess cash flows. Those excess cash flows are not necessary for expansion of the business. Therefore they result in the ability for the company to shower shareholders with more cash every year through regular dividend payments and increases.
The annual dividend payment has increased by 10.90% per year over the past decade, which is much higher than the growth in EPS. Future growth in dividends will be much lower than that however, likely around 7% - 8% annually, and will be limited by the growth in earnings per share.
A 7.50% growth in distributions translates into the dividend payment doubling every nine and a half years on average. If we check the dividend history, going as far back as 1987, we could see that General Mills has managed to double dividends almost every nine years on average.
In the past decade, the dividend payout ratio has increased from 40.30% in 2005 to 54.80% by 2014. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
General Mills has also managed to generate a high return on equity, which also increased from 22.50% in 2005 to 27.60% in 2014. I generally like seeing a high return on equity, which is also relatively stable over time.
Currently, General Mills is attractively valued at 17.80 times forward earnings and yields 3.10%. I am slowly building my position in the stock, and have been doing so this year. I have also sold some long-dated puts on the company, which have 50/50 odds of being exercised.
Full Disclosure: Long GIS, NSRGY and K
Wednesday, January 21, 2015
Successful dividend investors understand that a steadily rising dividend payment only tells half of the story. Most dividend paying companies that have been able to consistently raise distributions for at least one decade have enjoyed a steady pattern of earnings during that period of time.
As a dividend growth investor, my goal is to find attractively valued stocks that consistently grow their dividends. I run screens on the list of dividend champions and contenders using my secret entry criteria, and then look at the list company by company. Not surprisingly, I look for a record of increasing dividends. But I look for much more than that in a company.
In a previous article I discussed the three stages that dividend growth companies generally exist in. My goal is to focus on those in the second stage, although I might occasionally select a company from the first phase. However, I try to buy not just companies that have a record of raising dividends, but those that have decent odds of continuing that streak for the next 20 – 30 years. Not every company will achieve that, but for those that do, they would generate the bulk of portfolio dividend growth. The hidden source of dividend growth potential is expected earnings growth.
As you can tell from looking at my stock analysis reports, I look for companies that can increase earnings per share over time. Rising earnings per share can essentially provide the fuel behind future dividend growth. For example, Colgate-Palmolive (CL) has increased dividends for 51 years in a row. Over the past decade, it has managed to increase EPS from $1.17 in 2004 to an estimated $2.93/share for 2014. This has allowed the company to increase annual dividends from $0.48/share in 2004 to $1.42/share. The rest has been invested back into the business, to fuel potential for more earnings growth.
A company that is unable to grow earnings over time can only afford to grow dividends for so long. For example, Diebold (DBD) has managed to increase dividends for 60 years in a row through 2013, and had a very current yield. Unfortunately, the company has been unable to grow earnings as of lately, and the dividend payout ratio is reaching the limits of what a sustainable distribution could be. As a result, the stock has kept dividends flat in 2014, and as a result its streak of dividend growth is over. Therefore, the list of dividend kings will shrink for the first time since I have been tracking it.
Just as with dividend growth, I take past records of earnings growth with a grain of salt. You want to think about catalysts that would help propel earnings higher. For example, in the case of Colgate-Palmolive, the company has strong branded and relatively inexpensive products that consumers buy on a frequent basis. Most of these purchases are repeat business for Colgate – Palmolive, and consumers tend to stick to the brand of say toothpaste they have been using for years. Most consumers will stick to a brand whose quality they trust, and might not even notice a slight increase in prices over time. If you like Colgate toothpaste, and you care for your teeth, you would not substitute it for a generic brand that might be 50 cents cheaper. With this pricing power, Colgate can effectively manage to pass on costs to consumers. This could result in rising profits over time.
You can see that the qualitative analysis is important. If a company has strong brands, and competitive advantages, it can afford to increase prices, and that would not affect profits generated from loyal customers. This can generate profits to fuel dividends for years to come. For example, US companies such as Altria Group (MO) sell an addictive product, whose prices have been increasing for years. Despite the decrease in number of users over time, the increases in prices and constant looking for efficiencies has led to rising profits for decades. This stream of rising profits has fueled the dividend growth behind Altria, which has managed to reward shareholders with higher payouts for over 45 years in a row, adjusting for spin-offs of Kraft and Phillip Morris International (PM).
What you want to avoid is companies that offer commodity type products, companies that could lose leadership positions due to technological change as well as companies that are cyclical in nature. A commodity company is usually a price taker, not a price setter, and therefore does not have the pricing power of a Coca-Cola (KO) or Colgate – Palmolive for example. This can lead to erratic earnings, as prices would fluctuate depending on economic conditions for example. As a result, very few steel companies have managed to maintain an unbroken record of rising dividend payments. The only exception seem to be oil companies, some of which have been able to reward shareholders with rising payouts for over 25 years. This could be due to the nature of oil and natural gas, which once used, cannot be re-used, unlike other commodities such as steel and gold.
You also want to avoid companies which have gotten temporarily lucky. A prime example include some gold companies, which have records of raising distributions for one decade. Unfortunately, this coincides with the boom in gold and silver prices since the bottom in 1999. Even worse, many of these companies have pretty low payouts, which might make it easy to become a dividend achiever, but the paltry yields would be a turn off for investors.
Last, but not least, companies whose products or services could be deemed obsolete by shifts in technology, will not be able to earn sufficient profits to maintain a growing stream of dividend payments. Technology companies seldom have the durable competitive advantages that would make them holds for 15- 20 years. I cannot predict whether Intel (INTC) would still be in a competitive position in 2028 – 2033, or its products would be obsolete. However, I can pretty reasonably expect that people would still eat their favorite potato chips made by PepsiCo (PEP) or drink their favorite Coke or another one of the 500 drinks that the Coca-Cola Company (KO) makes.
In summary, a company that manages to grow earnings over time, should be able to afford to reward shareholders with a growing dividend income stream. Investors should analyze each company in detail, and determine if it has the qualitative characteristics that would allow it to grow earnings. If those characteristics are met, then the job of the investor is to acquire such securities at reasonable valuations as part of their diversified portfolio.
Full Disclosure: Long CL, PEP, KO, CL, MO, KRFT, PM, MDLZ
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Tuesday, January 20, 2015
I check the list of dividend increases every single week, in order to monitor companies I own, as well as uncover hidden dividend gems. There were several companies which announced increases to their quarterly dividends in the past week:
Omega Healthcare Investors, Inc. (OHI) is a real estate investment firm which invests in healthcare facilities, primarily in long-term healthcare facilities. The REIT raised its quarterly dividend to 53 cents/share, which is an increase of 8.20% over the same distribution paid in the same time last year. This marked the 13th consecutive dividend increase for this dividend achiever. In the past decade, the company has manage to raise dividends by 10.90%/year. Currently, the stock is selling for times 15.40 FFO and yields 4.90%. Check my analysis of Omega Healthcare Investors.
ONEOK, Inc. (OKE) operates as the general partner of ONEOK Partners, L.P. (OKS) which does the gathering, processing, storage and transportation of natural gas in the U.S. and owns one of the nation's premier natural gas liquids (NGL) systems. ONEOK Inc raised its quarterly dividend to 60.50 cents/share, while the partnership raised its quarterly distributions to 79 cents/unit. The increase over the same time last year is 51% for the general partner and 8.20% for the limited partner. The ten year dividend growth is 18.70%/year for ONEOK Inc and 6.50%/year for ONEOK Partners. ONEOK Inc yields 5.70% while ONEOK Partners yields 8%. Check my analysis of ONEOK Partners. I recently sold my limited partner interest for those of the general partner. I had a small remaining position in ONEOK Partners which I converted to Williams companies (WMB) last week.
Consolidated Edison, Inc. (ED) is engaged in regulated electric, gas, and steam delivery businesses in the United States. This dividend champion raised its quarterly distribution by 3.20% to 65 cents/share. This marked the 41st consecutive dividend increase for Con Edison, which is the oldest continuously listed stock on the NYSE – been listed since 1824.The ten year dividend growth rate is 1.10%/year. Currently, the stock is selling at 17.90 times earnings and yields 3.80%. I used to own Con Edison, but grew dissatisfied by the low growth and ended up disposing my position there. Check my analysis of Con Edison I posted on Seeking Alpha.
Fastenal Company (FAST), together with its subsidiaries, operates as a wholesaler and retailer of industrial and construction supplies in the United States, Canada, and internationally. The company raised its quarterly dividend by 12% to 28 cents/share. This marked the 16th consecutive dividend increase for this dividend achiever. In the past decade, the company has manage to raise dividends by 25.90%/year. Currently, the stock is selling for 26.50 times earnings and yields 2.60%. I plan on adding this company on my list for further research.
Linear Technology Corporation (LLTC), together with its subsidiaries, designs, manufactures, and markets a line of analog integrated circuits (ICs) worldwide. The company raised its quarterly dividend by 11.10% to 30 cents/share. This marked the 23rd consecutive dividend increase for this dividend achiever. In the past decade, the company has manage to raise dividends by 12.90%/year. Currently, the stock is selling for 21.40 times earnings and yields 2.70%. I plan on adding this company on my list for further research.
BlackRock, Inc. (BLK) is a publicly owned investment manager. The company raised its quarterly dividend by 13% to $2.18/share. This marked the sixth consecutive annual dividend increase for Blackrock. While this dividend contender kept dividends unchanged in 2009, it nevertheless has managed to achieve a ten year dividend growth rate of 22.70%/year. The stock currently sells for 17 times earnings and yields 2.50%. I am going to add Blackrock on my list for further research.
Full Disclosure: Long OKE, WMB and OHI
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Monday, January 19, 2015
Today marks the seventh year of me posting on Dividend Growth Investor website. I have posted different things on the site, but the overall theme has been to discuss investments, investment strategies, and thoughts on how to improve my dividend investing. The goal at the beginning, and right now and in the future is to build a portfolio of sustainable dividend growth stocks, which will produce enough in dividend income to cover my expenses every month. This is financial independence in a nutshell.
So why do I keep writing about dividend investing to the tune of seven consecutive years?
1) Make myself do the work to form an opinion. When you write things down, it is much easier to focus your thoughts and examine your thesis.
2) Share experiences and connect with like-minded individuals
3) Pass it forward – there is so much misinformation on internet about investing – I wanted to pass it forward and share the knowledge with others, same way I learned in the first place.
The thing that attracted me to dividend investing is that fact that I realized I would need a consistent return if I wanted to rely exclusively on investment income in FI/Retirement. When I earn dividends, I am reasonably certain about the amount and timing of dividend payments generated from my diversified portfolio. Hence I was instantly hooked once I learned about Dividend Growth Investing. However, I never really discussed that I had spent previously 9 years searching for the perfect strategy that delivers consistent returns to live off a nest egg. In the process, I found 100 ways of how NOT to make money, and only one of how to make money consistently - Dividend Growth Investing.
I don't mean to shamelessly self-promote myself but the truth my friends is that there are only two bloggers who have been writing continuously about dividend investing and documenting their strategy for over 7 years. That includes myself, and my friend Dividends4life. While the number of dividend investing sites has mushroomed, I have also witnessed the death of tens of other sites dedicated to dividend investing. Few have the dedication, patience and willingness to work hard for extended periods of time in setting up an income stream whose biggest fruits will be generated years down the road. Also, having the discipline to stick to one strategy, and not abandon it altogether are the cornerstones of investment success. Too bad few investors realize that they should find a strategy that works for them in realizing their own investment goals and objectives, while taking into consideration their knowledge and actual tolerance to pain. I know for a fact that when I start deviating too much from my strategy, I make mistakes. Hence, discipline has been key for my success toward potentially achieving my goals.
I believe that the skills that helped me continue writing my site for seven years are the same skills that have helped become successful as a dividend investor. With dividend investing, success is all about saving as much money as possible, and then investing that money in quality blue chip dividend growth stocks available at attractive valuations. The dividends generated by those companies are then plowed back into shares of more dividend paying companies, which pay more dividends on their part that gets put to use into more dividend paying companies etc. You get the picture.
The other item of equal importance is the fact that I was willing to sit through thick and thin on most of my investments, without selling too quickly. I say most, because I have done the mistake of thinking I was smart and trying to outsmart everyone else by replacing one company for another. In 9 out of 10 cases, I would have been better off simply doing nothing. Patience is an essential skill in dividend investing, and the need to act at all times is actually counterproductive. Successful dividend investing requires patience.
I have built my portfolio with quality dividend paying companies, which I will be happy to hold even if they closed the stock market for 10 years. In fact, in the event that I die or became incapacitated, my portfolio could simply exist in its current form, and just spit out dividends every month to the person/entity that gets ownership to it. That person could be your one year old kid/nephew/niece or your 90 year old grandma who doesn’t know the difference between preferred stock and livestock. I won’t go as far as saying that your cat or dog will be fine if they inherited that portfolio to live off the dividends however, because this in my opinion is plain crazy. But then, who am I to tell you what to do with your money?
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Friday, January 16, 2015
I posted the full analysis on Seeking Alpha in September. The thing that changed is that Target is now exiting Canada. By stopping the bleeding, the company can start generating more income right away.
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Tuesday, January 13, 2015
I kicked off the year with investments in two companies. Those are existing positions, which I am adding to. The companies include:
ConocoPhillips (COP), which explores for, develops, and produces crude oil, bitumen, natural gas, liquefied natural gas, and natural gas liquids worldwide. This dividend achiever has managed to increase dividends for 14 years in a row. It sells for 11.60 times earnings. Earnings per share for 2014 are expected at $5.62. For 2015, earnings per share are expected to go down to $3.72. This is down from an expected $6.34/share that Wall Street analysts were predicting just 90 days ago. At that 2015 rate dividend growth will likely stall. You might want to check my analysis of ConocoPhillips (COP).
I think the effects of sharp drop in oil have not been felt yet across the investment community. Many investors seem to believe that this is a short term event. In reality, I see a lot of players under pressure - from Oil producer states to unconventional exploration and production companies. The interesting thing about cyclical companies is that they appear cheapest near the top, but most expensive when things are closer to the cyclical bottom.
I see companies slashing capital spending, and a few flow-through entities cutting dividends, but I have not seen anyone go bankrupt yet. The magnitude of the oil collapse reminds me a little bit of the housing crisis, which spread through the economy and affected different sectors. This was preceded by a long boom and stories of boom towns, people who made a lot of money quickly, etc. I think the real risk is that oil fell by 50% from highs, yet stock prices on Exxon Mobil (XOM), Conoco Phillips (COP) and Chevron (CVX) are not down by as much. I think many are expecting a quick snapback up in oil prices. Therefore, many could probably be surprised negatively in the short-term (12 months from now). I am prepared for slow and gradual decreases in share prices, which would be great for an investor like me who has a set amount of fund to deploy to work every month, rather than invest a lump sum.
As I mentioned in the articles before, I am planning to slowly buying up shares in Exxon Mobil (XOM), Conoco Phillips (COP) and even Chevron (CVX). Companies like Chevron and Exxon Mobil are the ones that will survive drops to $40/barrel, and will benefit since they will be able to acquire reserves at a discount.
Conoco Phillips could benefit as well, although further sustained declines in commodity pricing below $50 could put the dividend in risk territory. I believe Conoco Phillips management is good at capital allocation, and runs the company for shareholders (as evidenced by sale of Lukoil (LUKOY) stake in 2011, and other projects while returning billions to stakeholders through share buybacks and dividends and spin-offs). I doubt they will cut the dividend, but it is likely dividend growth will be zero or very low for a few years if prices stay low for extended periods of time. I am planning to slowly buy things this year, and dollar cost average my way. ExxonMobil is probably going to be the next purchase in February and then possibly Chevron in March or April. Again, this is not a timing call. I simply have some amount to invest every month, and I like diversification, hence I buy stock over time. I don’t have $1 million sitting on my checking account, waiting to be deployed at once. But as I mentioned before, while prices are down, that doesn't mean they can’t go lower from here. Hence I am also buying companies with more durable earning streams throughout different phases of the economic cycle.
One example is Diageo plc (DEO), which manufactures and distributes premium drinks. This international dividend achiever has managed to boost distributions for 15 years in a row. It has a ten year dividend growth of 5.80%/year in its base currency the British Pound. Diageo owns a portfolio of strong brands, with wide consumer appeal, which are usually number one or two in their respective categories. A few include Smirnoff, Johnnie Walker, Guinness, Baileys, and Captain Morgan. The company also has a wide distribution network on a global scale, which might be difficult for a competitor to replicate. Diageo is the largest spirits company in the world, which provides it with the advantage of scale, relative to its competitors. The stock is attractively valued at 17.40 times forward earnings and has a current dividend yield of 2.80%. I would be even more excited if the stock drops further, since I have room in my portfolio for more of this quality company. Check my analysis of Diageo.
Full Disclosure: Long COP, CVX, XOM and DEO
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Monday, January 12, 2015
Imagine that you are able to receive a lump sum today, due to an event such as a sale of a business, cashing out of a pension, inheritance or winning the lottery. After you rejoice a little, you start asking yourself what to do with the money. I keep asking myself the same question quite frequently, and think my way through this “problem”.
If I received a lump-sum payment today, I would approach it differently, depending on the level of experience I have, the time I am willing to commit to investing per week, and the level and effort of continuing investing education I am willing to commit myself to. For sake of comparison, lets imagine that I am about to receive $1 million tomorrow.
The easiest option is to build a portfolio consisting entirely of mutual funds, covering indices such as S&P 500, US Total Market Index or a World Total Market Index. This would be in a situation where I didn’t know much about investing, didn’t have the time nor inclination to spend too much time on it, or decided it would have been too big of a hassle for me to pick stocks individually. I would basically put the money in a ladder of Certificates of Deposit first, and have an equal amount of those CD’s expire every month for 24 – 36 months. That way, I am mentally removing the pressure of having to invest all money at once, and I am also removing the opportunity to invest most of the money in my cousin’s business idea of a social network for cats (Catbook anyone?). As an equal amount of money is available each month, I will have it invested in the mix of stock funds. The purpose of dollar cost averaging is to avoid putting all the money at once, in order to avoid the risk of putting the money at the highest prices. By investing an equal amount each month, I am increasing chances that I will get decent prices for stocks I buy, and avoid overpaying. I will also miss out if prices keep going straight up for those 24 – 36 months, but that would be a risk worth taking, since it would also mean I would not put all money right before a major correction. The conventional way of this portfolio is to sell a portion each year to cover expenses. This could work in most situations, unless of course the stock market is down right when you start withdrawing or if the stock market is flat for the majority of time.
The other option I would take if I were willing to put the time and effort into it would be to invest the money in dividend paying stocks directly. I would still start with a CD ladder however, and put equal amounts into attractively valued dividend paying stocks every month for 24- 36 months. I would start by screening the list of dividend champions and dividend achievers every month, identify companies for further research, and put an equal amount of funds into the ten most promising ideas every single month. I would rinse and repeat every single month for 24 – 36 months. Over time, I should be able to gain some sort of understanding behind a large portion of those dividend champions, through regular reading and research about these companies. As the knowledge of each company is accumulated, it would be much easier to act. This process could take a lot of time at first, since it would require spending time researching whether the companies that met a basic entry screen are worth my money. After that however, additional follow-ups on each company should not take that much time each year on average. My goal would be to have a portfolio consisting of at least 40 different dividend paying stocks, representative of as many sectors as possible. That doesn’t mean owning utilities just so you own utilities. It means buying into companies selling at attractive valuation, but also making sure that I do not concentrate too much in a particular sector such as financials for example.
I would also build a portfolio around the three different types of dividend growth companies I have previously identified. The biggest mistake to avoid is focusing only on current dividend yield, without doing much additional work about its sustainability, potential for growth, understanding of the business etc.
Living off dividend income is pretty easy, once a portfolio is set up. When I receive dividend checks directly deposited in my brokerage account, this is cold hard cash I can do whatever I want with. I do not have to stress over whether we are about to enter a bear market, and I would run out of money simply because prices are depressed. I would receive cash dividends, which will get increased above the rate of inflation over time. I would likely accumulate all dividends for a three month period, then spend it equally over the next three monhts. If there is anything left over, I would reinvest it into more dividend paying stocks.
I have chosen of course to focus on selecting individual dividend paying stocks. It is cheaper in the long run to build a portfolio of dividend paying stocks, and rarely sell them. I only sell when dividend is cut or eliminated or when stocks are acquired for cash. I also try to outguess valuations from time to time, but my results have proven that I should not do that. In majority of situations, I am better off just sitting out there, doing nothing. This is the most difficult thing to do in investing.
My portfolio is generating dividends every month, quarter and year. The holdings I own tend to increase those dividends over time, maintaining purchasing power of income, and making my shares more valuable. While stock prices fluctuate from year to year, dividend income is always positive, it is more stable, and thus it is better tool to use when designing a portfolio to live off of. Plus, even the cheapest mutual funds that cost say 0.10% per year are more expensive on a portfolio worth $1 million, since they result in $1000 in annual costs. With brokers such as Interactive Brokers, I would have to make 1000 investments at $1/trade in order to reach the same costs per year. In addition, I would be able to hold on to most stocks and only buy shares in companies which I find properly valued, and possessing the characteristics I am focusing on. I could also avoid selling shares and incurring taxable expenses merely because an index committee decides to remove companies from their lists.
I like the fact that the companies I own provide me with fresh cash in a regular, predictable patterns. This is similar to what my experience is when working – receiving a paycheck at an equal intervals of time. With dividend stocks, I do the work upfront in selection at proper valuation, and then receive the cash for years if not decades to come.
In summary, it makes sense to spread out the investment of a lump sum received in order to reduce investment risks, and reduce the impact of mistakes. The investor who manages a considerable amount of funds should have the goal of preserving wealth first, so that it can last for decades. This will be achieved by spreading purchases over time, diversifying the portfolio in at least 40 individual securities from a variety of sectors, continuing their quest for investment knowledge and requiring quality and attractive prices in the types of investments they purchase.
- Why Sustainable Dividends Matter
- Dividend Portfolios – concentrate or diversify?
- Reinvest Dividends Selectively
- Dollar Cost Averaging Versus Lump Sum Investing
- Diversified Dividend Portfolios – Don’t forget about quality
Friday, January 9, 2015
Robinhood is a new broker, who lets customers purchase US stocks for no commission. Yes, that is true, customers pay no commissions when they purchase stocks using Robinhood. Unlike Loyal3, which also offers zero stock commissions, Robinhood offers access to almost all US traded stocks and the executions are real-time. With Loyal3, one has to wait for 2 – 3 business days before the investment is executed. However, Loyal3 is open to everyone right now, and has a lot of quality companies that allow purchases of fractional shares. All one has to do is have $10 to invest. Robinhood brokerage on the other hand is only available for a select number of customers today, doesn’t allow purchases of fractional shares, but executes trades right away. If this broker gets more established, I would put it on my list of best brokers for dividend investors.
There are several appealing factors behind Robinhood:
- Zero commissions on US Stocks
- No account minimums
- No Inactivity Fees
- No Deposit/Withdrawal fees
- Trades are executed right away at good prices
- Investor assets under $500,000 are insured by the SIPC
The items I don’t like are:
- Only available for a limited number of people
- Has not existed long enough
- Only available using an app
The service is not available for everyone yet, but will be launched sometime in early 2015. Currently, there are several hundred thousand customers who are in their waiting list. I was one of those users, but I moved up by signing up early, sending out invited, and sharing the information using social media. Thus, once the service becomes more widely available, I believe it could provide much lower fees to many beginning investors. To me, it would be much nicer to be able to allocate $2,000 - $3,000 into shares of 10 – 15 companies every month without paying commissions, rather than be limited to 2 – 3 investments for that month. Long-time readers know that I do not want to pay more than 0.50% in commissions on my purchase amount, and I also rarely sell.
So I signed up and last month was approved for trading. The email stated that I had to sign up within 72 hours of receipt, otherwise they would put me in the back of their waiting list. I opened the account, went to the usual forms of identification ( address, Social Security number etc), and then had to link my bank account information. I decided to put $100 in the application. Robinhood is SIPC insured, meaning that I am safe for amounts under $500,000 there, but it still a new broker. Therefore, I am not going to trust a material amount of money with it, until they prove to me that they are worthy of my dollars. After all, zero costs are fine, but it is also important that their system doesn’t crash when I want to make investments. It is also important that they keep my money secure, so that the chances of a hack attack are reduced. After I signed up, and account was approved, they prompted me to download their app on my smartphone.
The trades are executed only through a smartphone. While the sign up for the account was on my computer, the trading interface is only through that app on the phone. I know that this will be a very appealing feature for many younger readers, who can trade on the go. With commissions at zero, many investors will probably start investing more actively, which is usually a recipe for disaster for 90% of investors out there. I am relatively young myself (or at least consider myself that way), but I do not want to just be limited to an application on my phone when it comes to investments. Plus, if the app crashed or is being updated, I would not be able to make investments. For a buy and hold investor such as myself, I can afford to wait for a few days or minutes. But still, if I do not have access to a website where I can download statements ( the costs of a website shouldn’t be that high relative to that for an app), I am not going to invest much there. I cannot take that chance.
So how can a broker offer zero dollar trades? I believe that this broker will earn money by routing orders to exchanges that pay them fractions of a penny for order traffic. The broker will also earn money by potentially matching high frequency traders with your orders. The high frequency crowd essentially front-runs individual investors to earn a fraction of a penny per share, multiple times per day. As a long-term buy and hold investor, I do not care whether I buy Coca-Cola (KO) at $37/share or $37.01/share. The only thing that matters to me is that I do not pay more than 20 times earnings for Coca-Cola and that the earnings per share can grow over time, in order to justify valuation and generate more dividend growth in the future.
Another way that brokers earn money is by charging margin interest rates to their clients. Many like Schwab for example charge anywhere from 6% - 8% for margin loans (buying shares with borrowed money). Given the fact that money is so cheap today, this is a nice profit for the broker. The other way that brokers earn money is by lending out your shares to short-sellers, who pay them a short rebate. If Robinhood can somehow gain scale, and attract a lot of investors that trade often, they should do pretty well for themselves, once their fixed costs are met. In the business, a brokerage must meet steep regulation hurdles and costs, in order to handle client money.
The idea of zero commissions is very appealing nevertheless. If I were starting out today, and didn’t have a lot of money yet, I would use this application to build out a portfolio. I would watch out for other fees however. For example, it costs $50 to trade listed foreign stocks. It also costs $10 to make trades over the phone. Transferring securities out is another way where you will get hit by fees – there is a $75 outgoing ACAT transfer fee.
The idea of zero commission stock trades is not new. When I was first starting out with dividend investing, I used Zecco, which used to offer zero commission stock trades to investors. First they offered 40 free trades per month, then it was decreased to 10 trades/month. After that, the broker required a $2,500 minimum amount invested in order to be eligible for the free commissions, followed by an increase to $25,000, and then abolishing the free stock trades. Despite the increasing level of hoops however, for someone like me in the accumulation phase, it was helpful to be buying my first shares without incurring much in transaction costs. There are other companies like Wells Fargo and Merrill Edge which supposedly offer free trades every month to their customers. The problem is that there are just too many hoops to jump through. In the case of Merrill Edge, I have to have tens of thousands of dollars in a Bank of America account in order to qualify. The opportunity cost of $25,000 sitting in cash is higher than the $1 commission I pay at Interactive Brokers today.
I am going to keep a small amount of cash in Robinhood to test their platform. I bought a couple shares there, and the process was quick and efficient. Plus the prices I paid were fair. It was nice that I didn’t have to pay any commissions. Given the fact that this is a fairly new broker, that is untested, I am not going to put more than a few hundred bucks there. I have been using my broker Interactive Brokers as the main broker vehicle since the middle of 2014. I know that I pay $1/trade, which is more than $0/trade. In addition, for investors with less than $100,000 in assets there, Interactive assesses a $10 monthly fee. However I like the fact that my orders are directly executed on an exchange and that neither my broker nor a high frequency trader is trading against me on the order. I also like the fact that Interactive has been around for many years, is profitable, and very unlikely to go under and have my assets frozen for a period of time. I still keep under the SIPC limits there of course. It is very nice that I can buy shares cheaply at Interactive Brokers, and then transfer them to another broker that could have otherwise charged me $7 - $10/trade. It is also nice that Interactive Brokers charges around 1.50% on margin interest.
Either way, I am going to monitor Robinhood closely. In the future, once the broker becomes more established, I could start doing a more significant level of business there. Until then, I will keep my investing elsewhere.
- Best Brokerage Accounts for Dividend Investors
- How to buy dividend stocks with as little as $10
- Dividend income is more stable than capital gains
- Never Stop Learning and Improving
- How to retire in 10 years with dividend stocks
Wednesday, January 7, 2015
One of the dumbest arguments against dividend growth investing is showing a single investment that failed, and thus implying that the strategy is not good. An opponent of dividend growth investing would usually use a company like Eastman Kodak, General Motors, or one of the major banks like Citigroup (C) as an example of type of stocks that investors believed to be buy and hold forever.
There are several logical flaws with this argument.
The first issue stems from the fact that only some of the banks used in this argument have ever been dividend growth stocks at the time of their demise. General Motors, which was one of the bluest of blue chips for decades, had never been a dividend growth stocks, because of the cyclical nature of its distributions. Eastman Kodak was a dividend achiever once, having raised dividends for 14 years in a row through 1975, when the Board of Directors elected to freeze distributions. This was over 37 years before the company declared bankruptcy. Since 1975, the company had raised dividends off and on, but never for more than five consecutive years in a row. After the company cut dividends in 2003 however, no objective dividend investor should have held on to the stock.
The second issue with the argument assumes that there is a strategy that is better than dividend growth investing, which is why failures are always exaggerated, while dividend growth successes are simply ignored. The thing about every single investment strategy out there is that only a portion of the investments you make will be winners. Even Warren Buffett has not made money on every single investment he has made. The man is happy if he can find a 40% hitter, and stick to them. A rational investor cannot expect to win on every investment he or she makes. However, if they maximize their gains by sticking to their stock holdings that are successful, they would more than make up for the losers over time.
The third issue with this argument is that it ignores how General Motors, Eastman Kodak and the banks such as Citigroup were actually part of the S&P 500 or Dow Jones Industrial's Averages at the times of their dividend suspension or cuts. These companies were once regarded as the bluest of blue chips, and were members of all other major proxies for US stocks. If these are examples that should prevent investors from following a certain strategy, it looks like since these companies failed, the argument should be that investors should not buy stocks or should not buy index funds altogether. If investors are afraid that one or several of the companies in their portfolio will fail at some point in the future, they should never invest in index funds, or follow any stock investment strategy. Now that I have stretched the original argument, hope you can see its ridiculousness.
The other issue with the argument is that it ignores the fact that dividend investors hold diversified income portfolios, consisting of over 30 individual securities. If a few companies that the dividend investor has identified fail, that would surely hurt. However, the portfolio base would not be in dire straits, as the rest of the components would pull in their weight and raise dividend income over time to eventually reach record territory once again.
Another item with index funds is that they are not a magic panacea for poor investor performance. If the investor panics during bear markets, takes excessive leverage, or decides to wait in cash for months or years until the prices get cheaper, they might not make much money. Of course, index funds change approximately 5% of components each year. Those indexes look like daytraders when compared to dividend growth investors, who rarely sell, and hold through thick or thin.
The last issue with the argument is that it never provides alternatives to dividend investing. As a dividend investor I have spent thousands of hours researching and fine-tuning my investment strategy, and by digging through the information about the companies I am interested in. I have chosen to follow a strategy because it fits my goals and objectives. I typically ignore naysayers who tell me my strategy is bad, without providing me any clear alternatives to that.
In my dividend investing I expect that roughly 20% or so of companies I invest in will generate the majority of dividend and capital gain profits. The remaining will either break even or produce net investing losses. If the companies in the winning group go up tenfold in value with dividends reinvested over the next 20 years, with 40% doubling on average, while the companies in the losing group lose 50% of their value, I would expect that I would end up with a portfolio that could triple in value over a 13 - 14 year time period.
You are not going to come up ahead on all investments you make in your lifetime. But if on aggregate the ones you own end up throwing up more in income over time, you should do quite well for yourself.
In order to find quality dividend stocks for my portfolio, I start with the list of dividend champions, take them through my screening criteria, and then analyze each candidate one at a time. I then do the same exercise using dividend contenders/dividend achievers lists and try to make investments every month in those that offer the best values at the moment.
Full Disclosure: None
- Dividend Investing Over the Past Seven Years Was Never Easy
- Dividends Make Investing Easier During Market Declines
- Key Ingredients for Successful Dividend Investing
- Is international exposure overrated?
- Frequently Asked Questions (FAQ) About Dividend Investing
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