Now that we've established that we'd like to get our money working for us 24 hours a day in the stock market, we'll need a strategy for choosing our investments. I have chosen to start a dividend growth portfolio for my savings, and I’ll explain why I have done that below. We’ll cover a wide range of topics on this site, but the majority of the investing material will involve dividend investing, since that strategy best fits suits my personal goals. I’ll explain in more detail and you can decide if it fits your long term goals as well.
First off, what the hell is a dividend?
A dividend is a portion of revenue that companies pay out to every single shareholder, usually quarterly. A typical dividend payout usually ranges from 2.5-4% (of your total investment) annually. This will automatically show up in your brokerage account as a cash payment every quarter, which you can choose to withdraw or re-invest. This allows us to see some concrete earnings, and down the road, we can use this money as income. In the beginning, we'll use the dividends to re-invest back into a stock, which allows our income to snowball as we add in new capital as well. Dividends are not an earth-shattering amount of money, but the idea is that every dollar adds up when your portfolio starts to become sizable.
Why don't all companies pay out dividends?
Companies that choose not to pay out a portion of their revenue are typically smaller companies or companies in extreme growth phases. They use all of their revenue to try to grow their business. An example of a non-dividend payer is Amazon, who pays no dividend and is rapidly expanding into what seems like every freaking market in the world. These could be great stocks, but they don't fit into our strategy.
Why not just pick the companies that pay the highest dividend?
It's important to note that the piece of a company's revenue that they DON’T pay out in dividends is used to re-invest in their business. We can assume all these stocks are growing 7% per year like we discussed previously, so if the dividend is 3.5% annually, we can assume the other 3.5% is coming as growth within the stock price. It's also important to realize companies that pay a huge dividend with no sort of history of increases will likely be riskier than, say, Coca-Cola, who has paid a steady, increasing dividend for 52 years straight. Again, choosing safe companies to invest in will allow us to sleep easy at night.
What companies pay dividends?
One of the greatest parts of dividend investing is that you can see your money at work every single day. The companies that pay a dividend are consistently stable enough to know their approximate revenues and understand that they can safely afford to reward shareholders. By default, a lot of these will be companies that are woven into our lives on a daily basis. A couple examples are Coca-Cola, Pepsi, Target, Walmart, Procter&Gamble, Chevron, Exxon, Colgate, and Clorox. A lot of information on stocks are confusing for beginners, but you can worry a little bit less about your investment when you start your day brushing your teeth with Colgate toothpaste, head to Target and see a full parking lot, pull into Exxon to fill up your tank, or see the fridge in your office stocked full of Coke cans. It's then that we can almost forget about all the complicated ups and downs of the market and just know that what we own is still being used every single day right in front of us.
It lends itself to financial independence
Everyone has a different definition of "financial independence", but it essentially comes down to income replacement. We want our dividends to pay X% of our current salaries so we can spend some or all of our time doing something besides working for a living. For some, this is 100% of your salary, for others who want to continue working this might be a nice 20% replacement so they stress less about work or money. Personally, my goals revolve around spending time with future wife and any potential children we may have. I want an income stream that can support our current lifestyle so we have to work considerably fewer hours in the future. Our lives right now are pretty great, but if you removed the alarm clock from our lives, I’d venture to say they’d get a lot better.
So how do we quantify investment income? With dividend payouts! It’s very easy to track our progress toward this income replacement goal, as we see it growing every month slowly and steadily towards our goals. Easy motivation. Currently, I just passed $130 per month in income and I can actively see dollars being added to it every time I see a new dividend payment coming. When the time comes and I reach my goal, I will safely be able to count on those payments on a monthly basis to fuel…well…whatever the hell I want to do with my time.
Income without moving a muscle
I'd like to stress that we aren't working for this dividend income. We don't have to show up to work, make small talk in elevators, fake laugh at our boss’ joke, send/answer any emails, or even make any buy/sell portfolio decisions. We just sit on our asses with our shares and collect the paycheck. Life is beautiful when you can do whatever you want and still get paid for doing nothing. Isn't that the dream? This is what we are striving for.
Re-investing our dividends
Of course, we won't spend our dividend payouts on bullshit we don't need. We'll buy more stock with them until we can eventually live off that money. I get $130 per month right now - that's enough for 2 free shares of Coca-Cola or Target stock, which will then pay me another (small) amount per month for my trouble. Re-investing our dividends in the beginning will snowball our dividend income as it grows and grows.
Dividends lower our risk
When we look into the future 50 years from now, is it more likely that Coca Cola won't exist or Twitter? That's the general difference between a dividend stalwart who has paid out a steady, increasing dividend for 52 years and a company that is a recent sensation that pays no dividend. We manage our risk by investing in companies with HUGE operations, companies that everyone uses and sees every day. I'd venture to say some people over 50 years old have never heard of Twitter, but everyone knows what Coke is.
Another way our risk is lowered is that dividend payments can slowly pay back our principal. I’ll show you what I mean: If I buy $1000 worth of Coke stock today, and it pays me a dividend for 30 years on that same money, without re-investing anything, I will have received $1050 worth of dividend payouts. If Coke then goes out of business (not going to happen!), I will have pretty much broken even. This is considerably less risky than putting $1000 in Twitter stock, receiving nothing on a quarterly basis, and then having the stock price drop down to $0 and having nothing to show for it.
The last way is in the form of damage control. We will pride ourselves on buying safe and steady stocks but it’s inevitable that one of them will experience hardship and have to cut or reduce their dividend along our long path toward achieving our goals. This serves as a built in warning sign that we might need to get rid of our shares. Dividend decreases will always cause some panic and the price is likely to fall quite a bit if it occurs. But at this point, we know to evaluate what changed about the company and decide what action we need to take (hold or sell). We don't need to search for information or spend hours examining balance sheets on a daily basis to make sure our investments are all solid. We simply wait for a dividend decrease or cut and then go deeper into the facts from there.
Our money keeps growing even when we don't re-invest
When we are financially independent and laying on a beach somewhere (I'm picturing it now) and actually living off our dividends instead of re-investing them, when will we run out of money? Answer: NEVER! Our portfolio will have become self-sustaining. Remember when we said the average market returns are around 7%? If my stocks are paying me 3.5% in dividends, the other 3.5% is growing within the stock price. So by spending your dividends and leaving your portfolio alone, its constantly growing by the month. So while you will never run out of money in your lifetime with proper planning, you’ll also be able to leave your loved ones a giant self-sustaining portfolio when the time comes. Not a care in the world drinking my 1 (or 6) coronas on my reclined beach chair with white sand under my feet 🙂
Quantifiable Steps toward financial independence
As I've mentioned, we can easily track our progress with dividend investing based on our payouts. You know all those people who ask "when can I safely retire?" We don't need to ask that question, because financial independence won't creep up on us. We have our goal in mind and can see the progress every single month. We’ll know our monthly expenses and how much we need to cover them (with a proper safety margin). If you invest in index funds or non dividend paying stocks, when can you retire? The answer is we don't know, because we don't know whether our million dollar portfolio is going to be worth $500,000 or $1,500,000 in the next five years. It’s driven entirely off our stocks' temporary value, which no one can predict. We also never know the perfect time to sell off assets to create our income in retirement. If the market crashes and you lose 50% of your temporary portfolio value, you certainly don't want to sell off a good stock at a 50% discount. It becomes a stressful decision to make every month, and a decision that we will gladly decline to have!
How close am I to retirement? I want $2500 per month worth of dividends before I can achieve my personal interpretation of financial independence and I earn $130 right now, so I am 5% there. Based on my monthly investing, I plan to be at $300 per month at the end of 2016, so I will then be 10% of the way there at that point. How's that for simple? Ask someone without a dividend portfolio and I guarantee it takes them longer to answer, if they can answer at all.
Ok asshole, so what’s the catch?
The only catch is that this is NOT a get-rich-quick scheme; in fact I’m not sure get-rich-quick schemes even exist at all. It takes hard work and discipline to develop an income stream that is sufficient to live off of. If the average dividend pays out 3.5%, then we would need a $1,000,000 portfolio to generate $35,000 a year in dividends. What I love about this strategy is we can regularly see our progress and it will motivate the hell out of you. During our conversation on this site, we’ll buy into a more frugal lifestyle, which will in turn teach us to live on less. Some of us will never be able to live off of dividend income alone, and that’s okay. I’m pretty sure you’ll take whatever the free income is that you build up to. Hell, I’m pretty happy about the free $130 that I’m getting right now. It covers a few of my utilities and takes a small amount of pressure out of my budget. Now, picture how nice it will be with $200, $300, $1000 of free income per month, pretty fucking great right? I’m motivated every time I get a free couple of bucks and as it builds and builds, the feeling will only get better.
For those of you who already own stock, what are your favorite companies you've invested in that pay a nice dividend? Any long term success stories out there? Would love to hear some real life examples!