Friday, October 4, 2013

Do not despise the days of small beginnings

As a writer on a my website, I receive a decent amount of feedback from many readers through comments or emails. My recent article on the ten companies I purchased for my Roth IRA raised an interesting question. In the article, I had mentioned that it was better to invest $2000 in ten dividend paying stocks, rather than in just two.

My article was assuming that transactions costs can be maintained below 0.50%, and quality is not sacrificed. The question raised was whether it was worth it investing in dividend paying stocks at $200 per position.

The argument against investing $200 in dividend paying stocks was that the amount of the dividend would be so miniscule, that it would essentially not add any value to the investor. In other words, investing $200 at a time is probably not worth the effort.

I wholeheartedly disagree with this argument for so many reasons, that I decided to write a whole article about it.

1) The most important thing about dividend investing is to actually get started. That way, you get to put the power of compounding to your use for the longest time possible. If you put $200/month for 15 years in dividend paying stocks yielding 4% today, which raised dividends by 6%/year, and if you reinvested dividends over time, you would be earning $265 in monthly dividend income. While you would be earning $4 in annual dividends on the first purchase, after 15 years of persistent saving, investing and reinvesting, you would be generating more than what you are putting to work in your brokerage account. The power of compounding is strongest when you let your amounts work for you for long periods of time. To put it in perspective, if you put $200 at age 15, and let it compound at 10% for 70 years, you would end up with over $170,000 by your 85th birthday. Even after adjusting for 3% annual inflation, you still end up with close to $20,000 in inflation adjusted dollars.

2) The other reason is that one does not need a million dollars to get started with dividend investing. If you start with as little as $100 - $200/month, and you get to increase your contributions as your financial position improves, you have a very good shot of achieving your financial goals. Just by saving $100 - $200/month, you are ahead of most people in the US, who live paycheck to paycheck. Just remember that in order to reach your goal of financial independence, you would have to balance time to your goal, amount you put to work, and the investment return assumptions you are taking.

3) A third reason to start as soon as you have some money is because dividend investing is a cumulative learning process. When you start small, you can gain the knowledge on how to screen for dividend stocks, how to analyze them, how to select dividend stocks, and how to build and maintain a diversified income portfolio. You would also learn eventually not to panic during bear markets or not to get too excited when stock prices keep setting all time highs every single day. Those skills are highly scalable, meaning that if you know how to invest with $5,000, you also know how to invest with $5 million. For example, I spent several years learning about investing and paper trading, before putting actual money to work. I have found that you learn much more about investing, and the emotional side to it, when you have actual money on the line. Therefore, I would have been better off putting a few hundred dollars on the line, while paper investing.

4) A fourth reason to get started as early as possible is to experience the motivating factor of receiving passive dividend income. It is really refreshing to see your money work for you, and sending you a growing amount of dividends every quarter, no matter how small initially it is. I received my first “a-ha” moment when the first dividend payment hit my brokerage account several years ago. For the labor of identifying a dividend stock, and for the trouble of risking a small amount of funds on that idea, I was going to be paid a small but growing amount of income. I didn’t have to wake up at 6 o’clock, shuffle TPS reports all day long, deal with the eight levels of management above me, or get stuck in traffic for 2 hours/day to get my dividend payment. This dividend payment was also growing much faster than the salary raises most employees receive. Using this idea of dividends as a passive income source, I have been able to put every extra dollar to use in dividend growth stocks.

5) The fifth reason is somewhat of a repetition of everything from the previous four reasons. It is the story of Grace Groner, who was a secretary at Abbott Laboratories (ABT) who purchased 3 shares at $60 each in 1935. She then patiently reinvested the dividends for almost 75 years, until she passed away in 2010. At the time of her death, her investment was worth over $7 million, and throwing off over $300,000 in annual dividend income. If she had listened to the naysayers who would have told her that the dividend income from a mere $180 investment would be too low to be even worth doing, her estate would not have been able to leave millions of dollars to fund scholarships for generations of talented students.

6) Last but not least, putting a few hundred dollars to work per position might be a better alternative for most dividend investors, compared to making one or two large purchases per month. This applies to investors who build diversified portfolios of quality merchandise selling at attractive valuations over time, and who can maintain purchase costs below 0.50%. For several years i would buy stocks in $1000 - $2000 increments per position. Since I have 10 - 15 ideas at all times, this meant that I might wait for several months before I have the cash to buy more stock from ideas number 10 through 15. At that point, these ideas might be overvalued and no longer cost effective to buy. As a result, I would end up with plenty of companies which are a great long-term hold, although the positions are destined to remain low in proportion to my average portfolio positions.

By reducing purchase lot sizes, I increase my flexibility to add purchase shares in more than one – three companies per month. If I can keep commissions to below 0.50% overall, it is better to invest $2000/month in 10 companies than investing it in 2 companies.

Overall, in the past few weeks I have decided to start buying more than 1 – 3 positions per month, mainly by reducing my purchase size per position. I am essentially going to ramp up purchases in my Sharebuilder taxable brokerage account using their monthly plan for 12 transactions for 12 dollars. In addition, there are no additional fees to pay. Check my article on Best Brokerage Accounts for Dividend Investors.

The investments are made every Tuesday, and the stock prices I end up paying are very competitive. In my investing, I usually place the buy order in the morning before the stock market opens. I very rarely make investments during the day. With the likes of Zecco or Tradeking, I almost always managed to get filled at the open price. With Sharebuilder, I am actually getting a slightly better price in the aggregate. Of course, in the grand scheme of things, it doesn’t really matter if I paid $38.02/share for Coca-Cola (KO) shares using Sharebuilder, versus $38.27/share that I would have gotten with another brokerage. The most important thing is to look at the big picture, and not be carried away chasing pennies and losing dollars in the process. If my thesis is correct, 20 years from now Coca-Cola will trade anywhere between $120 - $160/share and pay over $4/share in annual dividends.

If I see a big drop in the stock of a company I am following and plan on purchasing, I might still purchase it in another account, especially if I believe that this is an opportunity that is short-lived. Sometimes, paying a $3 - $5 commission might make sense over a $1 commission, if it provides slightly more flexibility. After analyzing my investments however, I can attest that such purchases happen only 2 – 3 times/year.

Relevant Articles:

Dividend Growth Investing is a Perfect Strategy for Young Investors
Reinvesting Dividends Pays Off
How much money do you really need to retire with dividend paying stocks?
Dividend Portfolios – concentrate or diversify?
Check the Complete Article Archive

This post was featured in the Carnival of Wealth, Snowflake Edition

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