Dividend investing is an investing strategy that, as you may have guessed, is centered around dividends. Before we get into how I implement dividends in my portfolio and why, let’s first go over the basics for some of our newer investors.
Companies pay dividends similar to the way we pay off the interest accruing on our student loans. It doesn’t take down the principle and only increases our revenue that we take in. So if we have $1000 dollars in a company and they pay out $50 dollars in dividends, we still own $1000 dollars in company equity and that $50 that they paid out can just go into our pockets.
Understanding why a company may pay dividends is important when deciding whether or not it will fit into your investing strategy. A great example of a high dividend stock this is Ford (F). They typically payout 10% or more in dividends for the year (paid quarterly). That being said, they also haven’t been exactly appreciating in value. (See chart below.)
Basically, people don’t want to buy their stock because they don’t think it will be worth more. Heck, it’s been trading down for the past 8 years pretty consistently. So they are encouraging investment by paying interest (dividends) on the loans (stocks) that you are providing them.
Let’s say you are getting paid 10% a year in dividends but the stock price is falling 5% per year. You’re still up 5% right?
When you get paid that 10% you are getting paid 10% of the equity you have in the company. 2 shares at $500 dollars a share = $1000 in equity, 10% dividends, bing bang boom, you get $100.
But what about the next year? If it drops 5% you are looking at $950 in equity. 10% of that drops you down to $95 dollars in dividends. If that happens for a few years, your 10% dividend payment won’t be looking as lucrative as it once did… Which is why we keep that 10% in there.
Dividend Reinvestment, and why not doing it is stupid… Usually
So, let’s rewind. Let’s say you got paid your cold hard $100 dollars, but instead of buying stupid things, you reinvest it. Let’s say maybe you buy a fractional share (many brokers do this, although not all). That $100 dollars gets tossed into your account, the $50 drops off because you bought a non-appreciating stock and you walk away with a cool $50 or 5% profit! Not bad! Not great… but, not bad. The next year, instead of only having $950 in equity, you have $1050. Do you see how dividend reinvestment is a no brainer?
Why Dividends are good.
Dividends are good because they are typically safer investments in larger-cap companies. This means it would take a lot for them to go bankrupt (they still can though). It also provides a stable income if you want to take out your money. Those of you on the withdrawal side of your investment journey may want to consider it. Finally, if a company doesn’t know it’s worth and does end up growing, you may get both more equity, and dividends as a sweet bonus to get even more equity!
Why Dividend investing may not be for everyone.
One of the big things that makes dividends investing a bit trickier is that it gets taxed as normal income. With stocks, you can hold them for a year and get huge tax breaks, which for most of us means you won’t pay any capital gains tax. For dividends, they just count as income and you end up paying for it come tax season. It may not seem like much, but taxes taken out on a large part of your gains can be devastating in the long term.
Another big one is that you are investing in cash cows. This isn’t necessarily a bad thing. It can even smooth the ride for people with low risk-tolerance, but it often isn’t great for growth. In the example we ran through a bit ago, the investor only ended up with 5% gain for the year… That’s not a whole lot, even with 10% dividends. Companies that are growing rapidly are not paying dividends because they know people will invest in them due to their growing worth, not because they pay them more.
CPT CashFlow’s advice for you
I don’t advise. I’m not a financial advisor. I’m a dude who calls himself CPT CashFlow on a blog with 1 reader (yes you Punkin). I can, however, tell you how I’ve implemented them in my strategy and why. I have 17% of my portfolio in Ford. Honestly, that’s a lot more than I intended originally but I think the reasoning is sound. Times are rocky currently. I’m a bit of a pessimist and I think the market will drop again in the next 6 months. I plan on using the dividend payment from Ford to invest more in VTI once that drop occurs. It’s my way of dollar-cost averaging without holding onto money that could be invested.
My reasoning for why I believe the market will crash is a whole post on its own. I can tell you the headline is “New Investors don’t know turbulence”. It doesn’t exist yet but if you’ve been following along, I think you might be picking up what I will soon be putting down.
Thanks for reading, and remember: Save Money, Live Better, Just Do It, and Think Different.