Thursday, March 18, 2021

Staying Power

As an investor, you buy shares in companies in order to make a profit. You generate returns through a combination of price appreciation and distributions. 

In the long-run, equities generate better total returns than almost any other asset class. This chart is from the excellent book " Stocks For The Long Run", written by Jeremy Siegel.


The problem is that to earn these returns, you have to endure gut-wrenching volatility. It is not uncommon to see steep drops in share prices once every couple of years. Many of these declines can make even the most patient long-term investor question their position. This is why I do not focus on the fluctuations in share prices too much..

I like to focus on dividends, because that is real cash being deposited to my account for the privilege of owning a stock. When I focus on the dividend, and the dividend is well covered from earnings, I can ignore short-term noise and negative news, and try to focus on the long-term picture. This is difficult to do, if you only focus on share prices, bad news, and facts when things get bad. And believe, as a long-term investor you will see a lot of turbulence over the decades you are investing. That’s why you need staying power, that will provide you with conviction to stick to your investment plan through thick or thin. Getting paid to own and hold on to you stocks is a nice reminder that you have staying power.

When you stay invested, and you are not afraid of any short-term noise, you get to enjoy the compounding of your money at high rates of return. 


The following chart shows the price performance, quarterly dividends per share and annual earnings per share for Johnson & Johnson (JNJ). While share prices had rapid declines in 2000, 2002, 2008, 2015, 2018 and 2020, the investor who focused on the growing stream of dividend income would have been able to hold on tight, and even take advantage of declines. Getting paid a rising dividend every year provides the investor with the inner strength to stay invested, and even ignore fluctuations if they are retired for example. That statement holds true for as long as the dividend is maintained at least. In the case of Johnson & Johnson, this dividend king has increased dividends for 58 consecutive years, because it has managed to grow earnings per share over time. The dividend is also well covered by earnings.

The concept of staying power applies to pretty much anything else in life by the way. If you enjoy your job and career, you have staying power. You are more likely to try and do a good job if you enjoy your occupation. If you hate your job, and you are forced to work long hours for a difficult boss, you are less likely to stick to it.

In a similar way, when you invest in equities, you need to have staying power. You should invest money that you won’t expect for at least several years. If you really need the money soon, you are better off putting it in a lower earning asset that won’t fluctuate in price.

If you focus on the dividend income, which is more stable and easier to forecast than share prices, you can afford to ignore market volatility. The only way you will look for trouble is rooting for lower prices, when you have money to deploy. Dividend income is easier to forecast, and is more reliable than share prices. Historically, dividends in the US have increased at faster the rate of inflation.  US companies tend to have a culture to raise dividends over time. Only rarely do corporations cut or eliminate dividends. 

That is to be expected with some cyclical companies, or those that are about to enter a terminal decline. Another instance of massive dividend cuts will occur during an economic catastrophe, such as the Great Depression of 1929 – 1932 or the Great Recession of 2007 – 2009.  Even during these two cloudy periods for US Capitalism, dividends per share declined by much less than stock prices. Dividends are more stable, more reliable and easier to forecast than share prices. Other than that, it is pretty much smooth sailing. And while we had more dividend cuts than usual in 2020 due to Covid-19 shutdowns affecting businesses, the total amount of S&P 500 dividends in 2020 reached a record amount.

These features makes dividends the ideal source of income in retirement.  In my retirement plan, I focus on the end result, and structure my investing to show me immediate progress towards my goals. That’s why I focus on dividend growth stocks.

When you get dividends, you know how much you can spend safely. You have a lower chance of running out of money in retirement if you focus on dividend investing.  If you focus on selling shares to determine how much you can spend, you would have to use the services of a Math or Economics PhD, who will run complex formulas, statistical regressions and Monte Carlo simulations. With dividends, it is easier to budget, and to know how much you can spend safely in retirement.  If you multiply the number of shares in each company you own, times the expected annual dividend rate, you can easily see how much money you will receive over the next year.

When companies you own earn money, they reinvest a portion into growing the business, and send the excess cashflow to you in the form of dividends. Dividends impose a discipline on corporations to focus only on those projects with the highest ROI. Dividends also reduce the likelihood that managements will spend lavishly or try to build empires that will enrich CEOs, at the expense of ordinary shareholders. Patient shareholders are getting what they deserve: a four-times-a-year reminder that they, not management, own the company. When these investors receive dividends, they are focused on the long-term ability of the companies to pay and grow dividends. That ultimately provides them with the patience to hold on to their shares. That staying power in dividend investing is very important.

Dividends are underappreciated form of return today. But that’s because few people really understand investing, or have the knowledge or temperament to invest for the long-term successfully.

Relevant Articles:

Dividend income is more stable than capital gains

How to never run out of money in retirement

Dividend Investors Should Ignore Market Fluctuations


2 comments:

  1. enjoy your posts, I've enjoyed 500%, 600% and 700%+ gains by holding and dollar costing averaging in month after month....

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  2. You are certainly right. For me, the hardest part of buy-and-hold is not the big dips (which usually recover in 2-3 years, if not much sooner) but that long stagnant period from 2000 til ~2013. If I had a lump sum to invest right now, it would be hard for me to really go all-in on the market, knowing it's possible that the account could be mostly down for the next 13 years. Obviously it all worked out ok in the end and even if you bought and held at the peak in 2000, you'd be sitting on 160% gains after 21 years, or ~4.66% annualized gains, plus dividends which might add a point or two or more depending on the portfolio. So I end up hedging my bets when the market seems high like right now, even though I'm probably hurting my long-term returns.

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