The Power of Dividends & Having Fun

Experts like Warren Buffet will tell you it is very hard to pick individual stocks and beat the market, and he is right.  That is why people like Warren Buffet suggest investors stick to low cost index funds, add to them regularly and enjoy the power of compounding over many years.  For most people this takes place in their company 401k, which also can provide a match and powerful tax benefits, adding to the potential for growth.  It is the approach that is most likely to yield great results.  We like to call the combination of forces the Investing Trifecta, which we used to triple net worth in 8 years.

Dividends!

But this article is about the power of dividends!  First of all, what is a dividend?  A dividend is when a company spins a small amount of their profits back to the investors that own the stock.  Each share of the stock spins off a certain amount of income in the form of the dividend. That said, some folks like to take a small percentage of their assets (perhaps around 10-15%) and “play around” with individual stocks, crypto-currencies, or any other form of gambling one enjoys partaking in.  To me there is an entertainment factor here and a psychological one.  If you lose all the money it will not put your families future at risk.  At the same time this construct satisfies a human urge for some kinds of risk taking and fun.  Why are casinos packed every single weekend? If we are going to talk about the practice of owning individual stocks, think about stocks that provide a dividend.  How nice to own an asset that sends you a cash payment each month.  The business literally shares a small slice of their profit with you, one of the many “owners”.  These are stocks like Pfizer, Coca-Cola, Johnson and Johnson, IBM, Apple, etc.

Why I like dividend stocks?

One big reason I like dividend stocks is simple, most people can very easily purchase dividend producing stocks in small increments at a time to build a passive income machine. In contrast, it takes a huge amount of capital and time to buy rental property or own a small business. Also, in my opinion there is less concern about the normal up and down fluctuations of the stock market, as long as the dividend is steady or increasing. In addition, did you know that most of the gains from stocks over the years have come from reinvested dividends. Here are some of the dividend producing companies within the Vanguard Dividend Appreciation Index Fund:

Microsoft, Proctor & Gamble, Johnson & Johnson, Abbot Laboratories, Medtronic, Union Pacific, Costco, 3M, Lowe’s and Caterpillar…

Choose high quality Aristocrats or Kings

We like to focus on obtaining shares of companies that are large and have delivered consistent dividends over decades and in all kinds of economic environments. We do use some standard long term dividend stock criteria to analyze stocks to ensure their fundamental health is strong.

Do you DRIP?

DRIP stands for Dividend Reinvestment Program. This is basically when the dividend payment is automatically reinvested to buy more shares, which in turn produce more income and cash flow. One can have the dividends automatically reinvested, therefore buying more dividend producing stocks. This essentially amplifies the power of compounding! I do this with a Real Estate Investment Trust called Realty Income, ticker symbol “O”, which actually pays monthly. One of their slogans is “The Monthly Dividend Company”. At some point you may have enough of these assets to produce significant income each year without touching the principal. Caution though, it does take quite a few shares to generate substantial income, but this can be one aspect of your battle plan to conquer financial freedom. Put this together with other sources of income to support your life. But again, one nice thing about dividend producing stocks is that almost anyone can start building a portfolio today and add to it over time.

A good analogy for dividend stocks is planting a fruit tree. You plant the tree and feed it over time. At some point it just continues to produce fruit for you to consume without cutting down the tree. In fact, this is a great metaphor for any passive income machine you may set up. One thing I like about building a portfolio of dividend stocks is seeing the immediate progress each month. It satisfies that need for instant gratification as you add more shares and see the dividend come in each quarter.

For many years I have had $50/month taken directly out of my paycheck every two weeks and placed in a dividend producing stock. I have also had the dividend income reinvested by purchasing more stock. A general rule of thumb is that if you invested $30,000 in a dividend stock that produces a 3% yield, then you will earn $1,000/year in income. Regularly investing in a Dividend Reinvestment Plan (DRIP), in a few years you can amass a sizable amount in income producing dividend stocks. During our working years it may be best to have the dividends reinvested in order to acquire a larger number of shares. Therefore, when one approaches retirement perhaps they have $60,000 in dividend producing stock that provides $2,000/year in income. That could cover a good portion of your yearly grocery bill! Dividend stock investing can be a powerful force over time. In conclusion, if the dividends are reinvested and combined with the magic of compounding, one can build some substantial wealth. In fact, 91% of Warren Buffett’s portfolio is invested in dividend paying stocks. Here are some of Mr. Buffett’s dividend producing stocks: General Motors – 4.08% dividend yield Apple Inc. – 1.4% Coca Cola – 3.33% Some other stocks that offer a dividend: Pfizer – 3.7% Johnson & Johnson – 2.4% Realty Income O – 5.1% Amgen – 2.6% (Biotech) Verizon – 4.6% Qualcomm – 3.8% Some experts say to be cautious when a stock has too high of a dividend yield, say above 3-4%. It could be unsustainable and the stock could be beaten down for good reason. See Dividend Kings: http://oracle.davidkanter.com/2018/11/06/dividend-viking-kings-3m-ko-frt-jnj-awr/ This is in no way an endorsement of any particular stock. No one knows what stocks will go up or down over time. I prefer focusing on Dividend Kings and Aristocrats, companies that have paid consistently for 50 or 25 years or more!

Multiple strategies to FI

This is just one of many strategies one can deploy. Perhaps you already own these types of stocks as part of a low-cost index fund (probably the best way to invest in the market), therefore you are already sharing in the profits as the index fund spins off a dividend reinvestment. I checked some of my index funds and discovered in the history the regular reinvestment distribution of the dividends. One last thing I like about dividend stocks, I worry less about the stock value going down. In fact, when it goes down, the dividends buy more shares of that particular stock. I’m buying more and headed to the beach! A neat trick with these scenarios is to reinvest the dividend each month and create a self perpetuating stock buying machine.  Each month instead of taking the cash, one can have the company buy more shares for you, this is a DRIP, Dividend Re-Investment Plan.  I believe a psychological benefit to these plans is one actually can care less about the ups and downs of the market because when the stock is down your dividends are buying more stock.  This is just another potential strategy to build wealth in an automated fashion that takes very little effort on your part. Here are some other stocks that offer a dividend: If you have specific questions about specific stocks or DRIP information, please consult a fiduciary financial professional.

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