8 Reasons Dividend Stocks Beat Non-Dividend Stocks

Dividend Stocks

Stocks can be segregated into two groups – those paying dividends and those that don’t.   Of the two, dividend payers offer benefits non-paying stocks can’t, making the dividend payers better investments over the long run.  Below are 8 Reasons Dividend Stocks Beat Non-Dividend Stocks.

1)  Losses Mitigation:  Dividend payouts can offset losses in market value.    

If a non-dividend paying stock purchased at $100 loses 10% of its value, it will be worth only $90.

However, if a dividend paying stock bought at $100 and providing a $4 annual dividend (4%), loses 10% of its value it will drop to $90.  But as long as the dividend doesn’t get cut, it pays $4 which, if automatically reinvested, yields $94 worth of stock: the original $90 + $4 dividend reinvested. 

The $4 advantage of the dividend payer ($94) doesn’t seem like much but represents a 4.4% premium to the non-dividend paying stock ($90).  If you multiply that difference over thousands of shares accumulated during an investing career, the delta is substantial.  For example, the $40,000 difference between having $900,000 at retirement vs $940,000 may be nearly a full year’s income for some investors.

2) Principal Protection I:  The second reason div stocks are superior to non-div stocks is because they provide a level of principal protection unavailable with non-dividend payers.  

Dividend paying stocks generate income without selling off the principle.  If an investor with a non-dividend stock portfolio of $1,000,000 needs $40,000 in income she has to sell $40,000 from her portfolio to meet her needs leaving her with $960,000.  Consequently, her principal or nest egg diminishes over time.  In this condition, her best hope is that market value appreciation offsets the value of the stock she sold.  However, counting on Mr. Market to move ever upward over short investment horizons is a questionable bet.  

On the other hand, a dividend paying portfolio of $1,000,000 delivering a 4% yield generates income of $40,000 without selling any of the principal.  The investor receives her income and still has her $1,000,000 vs the $960,000 she would have had with the non-dividend paying stocks.  Her nest egg remains fairly constant relative to the diminishing next egg she would have to work with otherwise.

Of course, taxes will alter the figures above to some extent, but the principal protection advantage of dividend paying stocks remains unchanged.

  

3)  Principal Protection II:  The advantage of dividend paying stocks becomes greater during periods of bear markets.  If a bear market hits, when our investor from the previous post has to sell her shares to generate a $40,000 income, she will have to sell more shares at a lower price to meet her needs than she would if the share price remained constant. 

In a market in which her shares do not decline in value, she would have to sell 400 shares at $100 each to generate $40,000 in income.

However, during a bear market in which her share price drops to $80, for instance, selling 400 shares results in only $32,000 in income.  To reach $40,000, she has to sell an additional 100 shares generating $8,000 to get to her required income.  As a result of the market downturn she now has to sell 500 shares at $80 each to equal what she would have received for 400 shares at $100 each.

As a result of this math, she has 100 fewer shares than anticipated meaning any rebound in stock price has to account for the original loss in value plus the value of the additional shares she had to sell just to get back to even.

Conversely, if a dividend paying portfolio experiences a bear market, and the dividend remains constant, the value of the portfolio may decline, but the dividend payments do not.  Consequently, the dividend portfolio investor doesn’t have to recover the value of share sold nor replace the value of additional shares sold due to the lower price.

In short, not only do you benefit from the principal protection of dividend payments by not having to sell shares, but you don’t have to suffer the added “bonus” of selling more shares than you planned to because of an unexpected decline in market value.

4) Cash Flow:  Dividend paying stocks provide a stream of cash that doesn’t depend upon selling any of the principle.  The cash flow is generally regular and predictable – especially when invested in companies with long records (15-25+ years) of uninterrupted dividend payments.  This means it’s possible to think of a dividend stream like a second job… without actually going to work.  The technical term for this is, “wake up money”.  You wake up in the morning and collect the dividends.  With that said, the dividend income stream is not guaranteed… then again, neither is a second job.

5) Pay Raises:  Investing in stocks providing regular dividend increases makes it possible to watch your income grow.  Without going to work, improving your performance, or taking on a second job, dividend payers that increase their payouts serve up nearly annual pay raises.  Although the raises from dividend increases aren’t always large, they do compound.  Non-dividend paying stocks don’t offer the same benefit.

6) Power of Compounding:  Albert Einstein is to have said compound interest is the 8^th wonder of the world.  Whether or not that statement is accurate is debatable.  However, compound interest is still a powerful financial mechanism.  Dividend paying stocks held in Dividend Reinvestment Plans (DRIP) allow investors to make regular (monthly or quarterly) additions to a stock portfolio allowing those additions to compound over time. 

Non-dividend paying stocks can realize some level of compounding but the fact that investments of this nature are not always regular nor as frequent as a DRIP means the effect of compounding for these stocks lags that of regular dividend reinvestments.  Compounding is more effective through quarterly dividend reinvestment rather than done once or twice a year.  The more compounding periods you have for a given amount of money, the stronger the compounding effect.  It’s simply math. 

Regular dividend reinvestments represent a dollar-cost-averaging method of investing versus the market timing approach used in trying to determine the “best” window in which to invest.  The dollar-cost-averaging approach generally ensures some shares are acquired at lower prices resulting in a stronger compounding effect since more shares are purchased for a given level of dividend distribution.  Investors who add cash at irregular intervals may aren’t able to take full advantage of dollar-cost-averaging. 

Transactions costs (see the next point) associated with stock purchases further reduce the effect of compounding over time.  

7) No Transactions Costs:  Dividend paying stocks held in dividend reinvestment plans (DRIP) generally allow you to automatically invest dividends without incurring transaction costs.  A stock valued at $100 dollars paying a $4 dividend reinvested through the DRIP means that $4 of new stock is purchased each year while avoiding a brokerage fee for making that investment.  As I said, this is generally true, but there are exceptions so pay attention to the rules of the DRIP. 

The only way to regularly add to a non-dividend paying holding is by purchasing additional shares through a broker and paying the associated brokerage fees for conducting the transaction.  Siphoning off only a few dollars per transaction adds up with time and frequency diminishing compounding benefits noted previously.

8) Better Performance:  Given the advantages outlined, it’s not surprising dividend paying stocks perform well.  In fact, dividend payers outperform their non-dividend paying brethren over time.  Moreover, stocks that regularly increase dividend payments perform even better than those which simply maintain a constant rate.  Dividend payers not only outperform their non-dividend paying cousins, but they do so with less volatility allowing you to sleep better at night.  Who doesn’t like a great night’s sleep with solid “wake up money” in the morning?

The thoughts and opinions expressed here are those of the author, who is not a financial professional, and should not be considered as investment advice.  The information is presented for consideration and entertainment only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional. 

4 Things a Dividend Farmer Needs: Patience & Care

For the impatient investor driven by twitter bursts and the constant media barrage to buy and sell, patience and care are often in short supply.  Despite the low probability of riches with market timing and the stress it induces, many investors believe cycling their investments with velocity leads to glory.  And it does.  For brokers.

“Steady plodding brings prosperity; hasty speculation brings poverty” – Proverb

Transactions costs and losses taken when the timing is off doom investors engaged in frenetic trading activity.  Get rich quick schemes prompting the unwary to buy low and sell high generally result in investors who bought high, sold low, and suffered transactions costs both ways.  When the house takes you coming, going, and in between, it’s hard to get ahead!

How do you avoid this nonsense?  You buy solid companies paying dividends and do so at reasonable prices.  Then let time and compound interest work for you.  This plan is even better if you start early and stick with it.

If you recall the Ground post, selecting from Dividend Champions, Contenders, and Challengers is a great place to find solid companies at reasonable prices that pay dividends.  You still have to do your homework and wait for those moments when you discover one of your companies is a fit based on your personal investment criteria. 

After you make your purchase, hold for the long term and monitor your investment(s) on a regular basis e.g., monthly.  DO NOT monitor the hourly, daily, or weekly stock price.  Instead, pay attention to news articles and announcements about your firm to ensure it isn’t cutting a dividend, being acquired by a competitor, or suffering accounting irregularities like Enron. 

Aside from catastrophes like these, most media mentions of your portfolio companies are click bait to move the trading crowd to rash action.  For long-term investors, many articles are noise and should be treated as such.  You just need to be aware of the big events that could upset the apple cart.  Don’t blink.  Don’t panic.  Trust the odds are in your favor over the long haul and against you in the short-run if you’re a frequent trader.

Good ground.  Seed money.  Time.  Patience and care.  Dividend Farming leads to a good night’s sleep and solid “wake up money”.  From an investment perspective, what’s not to like?

The thoughts and opinions expressed here are those of the author, who is not a financial professional, and therefore should not be considered as investment advice.  This information is presented for education and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional. 

4 Things a Dividend Farmer Needs: Time

With good ground and seed money, a dividend farmer needs time for his crop to grow and mature.  The earlier the investing process starts, the longer the growing season, the larger the harvest.  This is true even if the seed money to start isn’t a lot and the additions over time are small as well.

Below are a few examples demonstrating the effect of time on the growth of your investment.

In the first case, a fresh college graduate is gifted $1,000, investing it at an annually compounded rate of 7%.  This is the approximate long-term average return of the stock market.  Assuming the student graduates at the age of 23, retires at 67, and simply lets her $1,000 investment compound between those ages, she’ll have $21,565 at retirement which is 21.5 times the amount of her original investment.

Conversely, if she didn’t invest $1,000 until 10 years later when she was 33 and let the principle compound at 7% as in the first example, her total would be only $10,730 at retirement.  Delaying the start of her “growing season” by 10 years caused her yield to fall to just under $11,000.  She reduced the time in which to grow her crop by 23% and shrank her harvest by almost 51%.  In this case, her return is only 10.7 times her original investment.  Now you have an indication of how important time is in growing a strong crop.

What happens if an investor regularly adds money as he goes?  The next case provides valuable insight as well.

In this case, a new college graduate is gifted $1,000 and invests it at an annually compounded rate of 7%.  This investor graduates at 23, works until he’s 67, and adds $50 per month to his principle.  Doing this over the course of his working life nets him $197,832 at retirement or 197.8 times his initial principle of $1,000.

However, if our intrepid grad delays his investment until he’s 33, adding $50 per month until age 67, his retirement take will be only $94,134 – over $100,000 less!  By reducing his growing season 23%, his crop yield declines by more than 52% relative to what might have been had he started saving and investing at 23.

Another way to look at the situation is to ask yourself how much extra will you have to invest if you wait to start farming?  If we return to our original investor example and ask how much extra would have to be invested at age 33 to receive the same $21,565 at retirement that she received by starting at 23, we get a remarkable answer.

If she invested $2,010 dollars at the age of 33 and let it grow at 7% she would receive $21,568 at retirement.  In other words, waiting 10 years to start farming means she has to invest more than twice as much as she did at the age of 23 to get the same result. 

Alternatively, she could start with the same $1,000 and add $6.50 per month to her account during the same period and receive $21,573.  This monthly increment doesn’t sound like much, but it means she needs to add $2,652 to her original $1,000 investment starting at age 33 in order to match what she would receive if she simply invested $1,000 at the age of 23 and let it ride.

These cases may seem like a lot of math to an individual investor.  Fortunately we have excel spreadsheets with a simple financial function that computes the future value (FV) of a sum of money given today’s value as a starting point and adding an interest rate, the number of compounding periods in the investment horizon, and the amount of additional payments made, if any, along the way. 

Every farmer has a number of tools at his disposal with which to tend his crops.  For dividend farmers, a good spreadsheet and basic understanding of a few formulas are invaluable.  Knowing about these tools and how to use them fall under the category of patience and care in the next post.

The thoughts and opinions expressed here are those of the author, who is not a financial professional, and therefore should not be considered as investment advice.  This information is presented for education and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.

4 Things a Dividend Farmer Needs: Seeds

Seed Money

Any farmer will tell you without seeds there won’t be a crop.  This is true regardless of the quality of the ground, the conditions during the season, or the skill of the farmer.

In dividend investing, you need seed money to begin your dividend farming operation.  Where do you get the money?  Many people live paycheck to paycheck or cycle increasing debt loads across a host of credit cards.  If you’re in this condition, check out Dave Ramsey’s debt snowball strategy. 

In a nutshell, Ramsey’s strategy is to pay off your smallest debt first.  Then apply the money you saved from the first debt as an extra payment on the next largest debt until it’s paid off as well.  Rinse and repeat the process until you’ve eliminated all your debt. 

This is a great way to dig out and generate seed money.  Primerica also advocates the debt snowball strategy, but does so in order to steer your eventual post-debt savings into its loaded investment products.  More about that in another post.

If you have a working spouse or you can swing a part-time job for a few extra dollars, then those might be sources of seed money for you.

Of course, if you have small discretionary funds or access to a flexible employer 401K that allows investments in individual stocks, you have the seeds you need to start farming.  You only need know how to start.

One thing you should not do, is borrow money to begin your dividend farm.  Don’t borrow from family, friends, home equity if you have any, or your 401K.  Even though dividend investing is among the more stable investment strategies it is not worth borrowing money to pursue.  The same can be said of most other investment vehicles with the possible exception of real estate, which is the topic of a future post.  

You’ve learned where to find good ground.  You have some ideas and a resource to help generate seed money.  The next ingredient needed in a solid farming operation is time.  Once you understand the power of time and compound interest you’ll see how fruitful dividend farming can be.

The thoughts and opinions expressed here are those of the author, who is not a financial professional, and therefore should not be considered as investment advice.  This information is presented for education and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.

4 Things a Dividend Farmer Needs: Ground

Money Ground

Without ground in which to plant, it’s hard to farm.  The same is true of dividend investing.  Without dividend paying companies in which to invest, it’s hard to be a dividend farmer.  So where can dividend investors find ground, maybe even good ground?

You could start by asking crazy Uncle Harry or your wild-eyed neighbor for investment tips, but I’m not sure I’d start there.

There are plenty of dividend-related blogs in the investing universe that offer ideas and analysis.  Be wary… the blog you’re looking at might be written by your crazy Uncle Harry or wild-eyed neighbor so proceed with care.

Having a conversation with a trusted financial professional is a sound course of action.  While I’ve gone down this road, I’ve found investment advice tied to brokerage commissions is a drag on your portfolio performance if you commit to buying through the broker providing said advice.

With that in mind, however, some brokerage tools can be helpful.  For instance, Fidelity account holders can use the firm’s stock screening tools to find dividend payers, but the filters are limited.  I’d imagine most brokerages offer similar tools which are good, but not great.

Yahoo Finance and similar sites are also sources of dividend investing ideas.  You can plug in a company name or ticker symbol and pull up a variety of information about the company in question.  This information normally includes the dividend payment and yield, but not always.  While this is generally a good source to check, you might find yourself searching for needles in a haystack as you plug one name or symbol into the tool after another, looking for potential dividend farming opportunities.

One very useful source I’ve discovered over the years is the DRIP Investing Resource Center.  Started over two decades ago by David Fish, the site provides regularly updated lists of Dividend Champions, Contenders, and Challengers.  The Champions, Contenders, and Challengers lists consist of companies that have raised their dividend payments for consecutive years:  Champions (25 or more years), Contenders (10-24 years), and Challengers (5-9 years). 

Fish's list provides more than an alphabetical breakdown of the companies in each category.   For example, you can see annual dividend growth rates in nominal dollars as well as percentage growth rates for each year in the period as well as current dividend payments and yields.

I’ve found the spreadsheet of Champions, Contenders, and Challengers to be a great resource for sourcing good companies with long histories of growing dividend payments.  If I’m going to plant investment money and take advantage of the reasons Dividend Stocks Beat Non-dividend Stocks, then planting money in good companies is equivalent to planting crops in good ground.

The thoughts and opinions expressed here are those of the author, who is not a financial professional, and therefore should not be considered as investment advice.  This information is presented for education and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.

4 Things a Dividend Farmer Needs

Traditional farmers need 4 things to successfully grow agricultural crops.  Dividend Farmers need four things to grow their financial crops as well.

Money Seeds

First, farmers need ground for planting or companies in which to invest.

Second, seed must be put into the ground and money into the investment.

Third, time is required for the seed or money to grow and produce.

Fourth, traditional and dividend farmers must exercise patience and care during the growing season.

Good weather and markets are also important, but farmers can influence the first four items to a greater extent than they can Mother Nature or Mr. Market.  Consequently, I’ll share thoughts on how traditional and Dividend Farming are related during the following four posts.