Being a dividend investor is among the easier ways to invest in stocks.
I believe that the psychological side of investing is just as important as the math side. If your investing approach doesn’t “feel right” to you, investing can not only make you miserable, but you will be prone to mistakes and departing from your general plan.
When people are young, goals like beating the market and becoming rich tend to dominate their thinking.
But later in life, goals like having plenty of income for retirement and never running out of money move up in importance. Stocks that pay dividends move up the list of “best stocks.”
Many investors, including myself, have found that investing in companies that pay regular, reliable, and growing dividends is the easiest way to meet the basic test of investing as laid out by Warren Buffet and others:
How much cash are you going to get, when are you going to get it, and how sure are you?
Let’s explore the reasons that dividend stocks make investing easier.
Dividends Provide Regular Income
Dividends are direct payments from a company to its shareholders. Thus, a portfolio of dividend stocks provides regular income.
It may seem obvious, but because dividends are direct payments, they completely bypass the stock market. They are transactions between a company and its shareholders that the market is not involved in.
The absence of the market from dividend distributions is one fact that makes dividend investing easier.
Dividend payments are completely uncoupled from the stock’s price. Prices go up and down all the time at the whim of traders, but dividend companies declare and increase dividends on their own schedules.
Dividends and prices do have a common source, namely corporate earnings and cashflows.
Unfortunately, however, the way the stock market works is that Mr. Market sometimes spins his Hot and Cold dials, taking stock prices through irrational swings that have nothing to do with the actual business success of the companies being traded.
Source: Author
With Mr. Market out of the picture, dividends are usually much smoother and more predictable than stock prices.
Let’s look at an example. PepsiCo (PEP) is an iconic dividend-growth (DG) stock. It has an extraordinary record of not only paying, but also raising, its dividend every year for decades, as shown on this display.
Source: Simply Safe Dividends
Mr. Market has taken Pepsi’s price up and down repeatedly. But the independence of dividends from market prices means that the best dividend companies, such as Pepsi, provide significant emotional insulation from turbulent markets.
That makes dividend stocks like Pepsi easier to hold and to not over-trade.
In fact, for a dividend-focused investor, the term “stock market” takes on a different meaning. The market isn’t a scary, mysterious place. It is simply a store where you can buy, and occasionally sell, stocks.
You do not go there to engage in trading battles.
Dividends Help Relieve Obsession over Market Volatility
Many dividend investors find that their growing income stream lifts a great worry off their shoulders: They no longer fret about stock prices.
The investing industry and media are fixated on the drama of stock prices.
CNBC's programming is built around that drama. Using alarming red and soothing green colors, the barrage of short-term price information influences investors to think that investing is all about a series of short-term wins and losses, with the score being measured by prices.
Source: CNBC
The red colors and negative numbers generate fear and a flight response that causes many investors to sell (cut their losses) as prices drop.
Dividend stocks help alleviate this self-defeating impulse by providing real dollar returns that arrive in cash.
On the following 20-year chart, Pepsi’s dividend payments are shown in orange, while its price is blue.
Source: Simply Safe Dividends
I circled several time periods where Pepsi’s price took significant dips. We know that they caused fear, because ultimately stock prices reflect supply and demand. When prices dip significantly, or zigzag without reason, it is because people who wanted to sell dominated the market’s action.
Here is the largest circled area expanded so you can compare Pepsi’s price action (controlled by Mr. Market) to its dividend returns (sent directly by the company).
Source: Simply Safe Dividends
The snapshot is from the Great Recession (2007-09). You can see that over about an 18-month period, Pepsi’s price dropped over 30%.
But its dividend rose 20%. The negative market action had no impact on Pepsi’s decisions to raise its dividend twice while its price was crashing.
I held Pepsi during that period, and I can say from personal experience that those two dividend increases made it easier to continue holding it. In fact, I still hold those same shares today.
Dividend investors are, to a degree, set free from constant concern about stock prices. They are insulated from the fear of falling prices by the cash that the company sends their way every quarter.
Studies show that the “average investor” underperforms the stocks they invest in. While at first that may sound impossible, it is true – because investors jump in and out at bad times.
If you sell a stock when its price is falling, then wait too long to get back in when the market reverses, you will underperform the stock itself. That’s the way the market works.
The net result of that behavior is to be in cash too much. Being in cash instead of the stock means that overall performance lags what it would have been had the investor simply held onto the stock.
Refer back to the PepsiCo graphs above. The ride on the orange line is smooth and positive. It generates no fear. The only real unknown is how muchPepsi will raise its dividend next year. It is a near certainty that they will raise it.
With a great dividend stock like Pepsi, there is little temptation to sell when its price drops. I barely know what Pepsi’s price is on a monthly (let alone daily) basis.
What I do know is that my income from Pepsi goes up every year, and its capital value (based on its price) goes up over time too.
Dividend Investing Allows You to Set Realistic Goals that Can be Tracked
Dividends are far more predictable than prices.
There is risk, of course, in every investment. Corporate dividend policies are not contracts, nor are dividends guaranteed.
Nevertheless, compared to stock prices, dividends are far more reliable and predictable.
Hundreds of companies have a long history of increasing their dividend regularly. I have put four of the best dividend stocks on this display to show what they all have in common: Annual dividend growth.
Source: Simply Safe Dividends
Just to be clear: These are not price charts. They are dividend charts.
With companies with records like these, it is logical to expect that they will continue to increase their dividends every year if they possibly can.
At Simply Safe Dividends, we help you feel safe about dividend increases with our Dividend Safety Scores™ highlighted at the top of every company page.
Source: Simply Safe Dividends
The scores are intuitive. On a 0-100 scale, dividends that get 81+ points are considered to be very safe – very unlikely to be cut.
Source: Simply Safe Dividends
Besides Pepsi at 93 (Very Safe), the other scores in the earlier display are McDonald’s 77 (Safe), Realty Income 80 (Safe), and Johnson & Johnson 99 (Very Safe). (Disclosure: I have owned all four companies for years.)
You Do Not Have to Sell the Stock to Get the Dividend
Dividends are sent directly to shareholders by the company.
When you buy a share in a dividend stock, you receive an important benefit of ownership: The right to receive future dividends from that company.
As we saw earlier, this helps you bypass the irrational intermediary – Mr. Market – that stands between you and your stock’s price. You do not have to worry about what he is up to. You will get your dividends no matter what.
In contrast, if a stock pays no dividends, you can only realize returns if you sell the stock. Combined with media hype about what the stock market is doing minute-by-minute, that leads many investors to be deeply concerned about stock prices.
That concern makes investing harder, because prices go down almost as much as they go up.
Source: Sather Research
The study illustrated above shows that prices go down around 45% of the days that the stock market is open. That is a lot of time to spend worrying about the market.
Dividend investors, however, often see stock shares not as lottery tickets, but rather as proof of ownership in cash machines that generate streams of income.
You do not have to dispose of shares to realize that income. That is important, because receiving dividends does not deplete the number of shares that you own.
All of your shares remain in your portfolio after you receive each dividend payment. In contrast, a sold share is gone, and it can no longer benefit you.
If you are young now, I can tell you this: When you approach retirement age, you will appreciate not needing to deplete your assets to pay your bills.
Dividend Growth Companies Are Usually Outstanding Businesses
It is easier to sleep at night if you own outstanding, time-tested businesses that can afford to pay and raise dividends without jeopardizing themselves.
Dividends cannot be faked. A company must have cash to pay them.
Dividend-growth companies are typically strong enterprises with:
Reliable generation of excess cash above and beyond what the company needs to thrive and to grow.
The fact is that it requires an outstanding business to increase its dividend for many years in a row. Weak businesses simply cannot do it.
The excellence of these companies reduces worry and stress. Dividend investors know that they don’t have much to worry about when they are invested in companies that provide dividend safety, reduced price volatility, and long-term predictability.
Conclusion
As a dividend investor, your mindset is to profit from owning shares of great businesses rather than by placing bets on Mr. Market’s whims.
After I reorganized my investing strategy around DG stocks in the 2007-10 period, I found that I was no longer stressed about stock price fluctuations.
Whether my stocks’ prices go up or down, I know I will receive some of their earnings every year directly from them.
The market can contract for a day or a week, and I really don’t care. Life got easier. I sleep well at night without worrying about how my stocks are doing.
If you build a strong portfolio of great dividend-paying stocks that regularly increase their dividends, you can arrive at retirement with a significant income stream paying an enormous yield on your original investment.
You may be able to switch over from a salary paycheck to a "dividend paycheck" seamlessly. And you may be able to finance a comfortable retirement without needing to sell any of your assets.
Source: Author
