Wednesday, October 1, 2014

You don’t need to be right all the time to succeed with dividend investing

One of the simplest truths about dividend growth investing is that not all companies you select will do as expected. Some will fail outright, while others will merely deliver some dividends which would barely match the rate of inflation. Based on studies I have performed, I have noticed that another small group of stocks will provide a large portion of returns in a dividend stock portfolio. You might not realize at the time of purchase, but the reality is that it is difficult to say in advance which company will do the best.

Even with those odds however, a dividend investor does not need to be right about all stock selections. In fact, even if they are correct for about 50% of the securities they pick, they should do fine as long as the dividend increases and capital gains from the winners offset the capital put to work in the “losers”. This of course is a very worst case scenario, since many of the “losers” will keep paying a slowly rising dividend, which could be spent or put to work into other dividend paying stocks. Therefore, I know that even by selecting my fair share of “losers”, I still have a very high chance of living off dividends. I follow a few principles to ensure I have the odds in my favor for a successful dividend investing.

This is why I stick to a few fundamental principles. The first principle is that I always strive to create a portfolio of dividend growth companies which are in one of the three types. The main goal is to be patient, and enjoy the ride. I view my portfolio like a a symphony. Each company in it has a role to play and together they make beautiful, income producing music. It is important to diversify risk with at least 30 – 40 securities, which will be purchased slowly and over time. Diversification helps when the proverbial bad apple takes a bite out of dividend income.

The second principle is to have patience. I have learned the hard way that once I purchase shares in a company I like and at a valuation I like, I should let it quietly do the compounding for me. I am a long-term investor, and my holding period is the next three decades. I am hopeful that my dividend portfolio will provide growing income for the next 30 years. This is why I need to view things in perspective, and think about longer term trends that span years, rather than get scared away from a single bad quarter or a single bad year. In the grand scheme of a 30 year investing time frame, one or two years are almost irrelevant data points. That doesn’t mean not to sell if there are any troubles brewing – it just means not to jump ship at the first “correction” or sign of “trouble”.

The third principle is being really selective about selling. After reviewing data about investor performance and psychology, I have come to believe that those who sell too quickly face reinvestment risk. Many investors tend to get a gain in a stock, see that the yield has gotten too low, and sell to get into a higher yielding security. As a result, they end up paying taxes, having less capital to invest, and in a large portion o the cases they end up with less in dividend income growth and capital gains than if they had patiently sat on their hands.

When you buy a stock, the worst think that can happen is that it can go to zero. The next thing that could happen is that you keep earning dividends, which reduce the amount you have at risk in the security, and then put those to work into more dividend paying stocks.

This is where the fourth principle lies in – hold on to your winners. The best case is that the company ends up performing like the next Wal-Mart (WMT), McDonald’s (MCD) or Coca-Cola (KO). You do not know at the time of purchase whether the company you picked will be profitable and paying more dividends in 30 years. You can make an educated guess, but the truth is you will not know which of your 40 stocks will be the best and which one will be the worst by 2044 – 2050. This is why I am trying to be as passive as possible, and reduce reinvestment risk as much as possible. I am often afraid that I will end up selling the next Coca-Cola (KO) to buy the next Jones Soda (JSDA), than missing out on the next Sigma-Aldrich (SIAL) because I stuck with Coke.

What I am trying to say is that with dividend stocks, your losses are limited, but your gains are unlimited and potentially much more than the amount you have at risk. This is why mistakes of omission, or the opportunity cost of not getting into a company prior to take off is a bigger problem than buying a bad stock. This is why I keep holding on to my winners, even if they end up delivering over 1000% profit.

Investors need to think probabilistically. In their portfolio of say 40 securities, there will be 10 which will likely do most of the heavy lifting for the next 30 – 40 years. If you sell those today, your portfolio will be mediocre. This is why it is also important to give companies a chance, provided you understand them well, they are available at a good price, and there are catalysts for future earnings growth. However, even for those who are average, it is helpful to understand that with each dividend check, the amount at risk in those securities is reduced. Therefore, even if in 2007 you had owned Bank of America for 20 years, you would have had received enough dividends to put in other dividend paying stocks that would almost cover for the capital you put to work initially

Full Disclosure: Long KO, WMT, MCD,

Relevant Articles:

- Accumulating Dividend Stocks is a Long Term Process
Dividend Stocks For Long Term Wealth Accumulation
When to sell my dividend stocks?
How to generate income from your nest egg
Dividends Offer an Instant Rebate on Your Purchase Price.


  1. Completely agree with you on buy and hold. Having said that I did recently sell off JNJ and bought KMI. Overall, so far, it was the right decision as KMI has increased in value to offset what i "lost" on the JNJ run up and as well I have doubled the dividend payout. DO I regret selling JNJ? In hind sight (20-20 vision) maybe I should have held on but I was of the opion that JNJ had entered a stagnation range and I saw mor efuture in oil.
    So I have held on to several stocks through their downfalls and revivals all the while re-investing the dividends I received. Presently carrying around 25-30 stocks based in REITs, finacials, oil/pipelines and lately a few "seniors" residences administrators which I guess could loosely come under a REIT classification.
    My main goal is to increase dividends by 10% per year through contribution to my retirement funds, re-investment of dividends and dividend increases by the equities prsently in the portfolio. How am I doing for this year? Presently on track for a 25%-30% increase. As the years go by it has been interesting to see the dividends increase irrespective of how the market has performed. Remember that if your dividends increase every year you can buy more equities in adown year and reap the benefits of more dividends and an increasing principal as the market recovers. It is a yo-yo market at all times. Set your self a goal and stick to it.

    1. I am not sure I understood the reasons why you sold JNJ. Unless I am missing something, you might be starting on a way to chase yield. That could be a dangerous activity.

      A portfolio consisting of oils, financials, REITs can benefit from some consumer staples from a diversification perspective. I keep pounding diversification all the time on this site. I also keep pounding on the idea that sustainability of dividends is important, and more so than a juicy high yield.

      Good luck in your dividend investing journey!


  2. DGI,
    Nice analysis. I have one more thing to add to your list, a mistake that I have made a couple of times. That is, you buy a stock in a great company but the price immediately drops. You start to wonder if you made the right decision and second guessing your purchase. You don't see immediately, but once you get back to break-even you bail out. Uh huh, then the stock continues to climb because, don't you know, it's a great company and the market decides it's worth much more than it's selling for. Do your homework, buy great companies, and stick with 'em. That's a recipe for success.

    1. Should be, "You don't SELL immediately, but once you get back to break-even you bail out."

    2. Frankly, I am beginning to believe that one should be as passive as possible, once the dividend portfolio is set-up. There are reasons to sell, but I think most investors focus way too much on the price. In reality, Buffett has a very smart saying that unless you are willing to commit to buying a stock even if they closed the stock market for you for 10 years, you should not buy that stock. I try to build my portfolio that way - if I were to become incapacitated tomorrow, or worse even - die, I believe that my portfolio is set up in a way that someone with no basic intelligence can simply sit on it, and collect the dividends to spend.

      I am also nto a big fan of stop losses. Based on what I have learned about stock market investing in the past 15- 16 years, I would not do stop losses as a long-term investor.

    3. Right, buy great companies at reasonable valuations and let them do the work. Passive investing has the greatest probability of long term success.

  3. I think the same, even more so, can be same for indexing DGI.

    This said, once you own about 30-40 dividend stocks for diversification, you have basically created your own small index.

    If you're looking to live off your capital, I think this is the way to go....dividend investing.

    1. I would call it portfolio, not index. An index is something that is created by someone else, which changes composition on you without any input from you. As for living of capital, I agree that dividends are always positive, more stable and therefore ideal as a way to live off them.

  4. DGI, If a stock spins off and the parent company is a dividend champion or aristocrat and the spin off company does not pay a dividend how many years should I hold it? It could take several years like aapl or ice. Suzanne


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