Wednesday, June 18, 2014

Investors Should Look for Organic Dividend Growth

The goal of every dividend investor is to have an active plan in service that will allow them to reach the dividend crossover point. This occurs when dividend income exceeds annual expenses for the first time. In order to achieve this, investors can rely on new contributions, the compounding power of dividend reinvestment and on dividend growth from their positions. Over time, these three powerful forces will be able to propel the passive income of our investor until they reach their goal. However, I think that investors need to also asses their portfolios at least once – twice per year at the very least.

Investors need to continually stress test their portfolio assumptions, in order to gauge whether their dividend machine can live up to its full potential in retirement. Investors need to understand if their portfolio would have produced increased income even if no new funds were added or if no dividends were reinvested. This is a very important step in dividend investing for retirement that would ensure that income is growing over time. Growing income is important, in order to maintain purchasing power of your dividend stream. For example, even if inflation was a low 3% per year, your purchasing power declines by 20% in year 7, 40% by year 17 and over 50% by year 24.

My expectation is that my dividend portfolio will deliver a six percent annual dividend increase, without adding any new money. For example, if I had a portfolio yielding 3% today valued at $100,000 I would generate $3,000 in annual income. If I add $6,000 to the portfolio in stocks whose average yield is 3%, I would have increased my dividend income by 6% to $3,180. Without new money, this income stream would lose purchasing power over time, which is a dangerous proposition in retirement. However, if the original stocks this this portfolio yielded 3% but also grew distributions by 6%/year, the distribution would be $3,180 without having to add $6,000 to the portfolio. As you can see, if all things were equal, organic dividend growth could be very valuable weapon in your quest for financial independence, because the internal compounding results in lower needs for capital to be placed in-service into your dividend machine.

In my income portfolio, I always look at my holdings at the end of the year, and then ignore any additions or deletions I made since the beginning of the year. I assume that I didn't add any funds and I also assume I put all dividends received in my checking account. I took a look at my starting portfolios at the end of 2008, 2009, 2010, and 2011 to come up with the following organic dividend growth rates:

Dividend Growth

I was building out my portfolio throughout 2008, which is the only reason why an organic dividend growth rate was not calculated for that year. In comparison, the dividend income assuming dividend reinvestment and new money addition was much higher.The cuts in General Electric (GE) and State Street (STT) really prevented me from achieving organic dividend growth in 2009. Since I reinvested the funds from the stocks I sold however, my total dividend income increased in 2009, even before accounting for purchases I made.

To summarize, I believe it is important to invest in companies that regularly increase dividends for their shareholders out of the earnings growth their business generates. This results in an increase in dividend income that is much cheaper for the dividend investor, and doesn't require constant reinvestment of dividends in order to keep up purchasing power or increase income.

Full Disclosure: None

Relevant Articles:

How to Generate an 11% Yield on Cost in 6 Years
Reinvest Dividends Selectively
Replacing dividend stocks sold
The Sweet Spot of Dividend Investing
Dividend Investing vs Trading

Popular Posts