As an investor, you buy stocks in companies for profit. You achieve returns through a combination of price increases and distributions.
Over the long term, stocks produce better total returns than almost any other asset class. This table is from Jeremy Siegel’s excellent book, Stocks For The Long Run.
The problem is, to get those returns, you have to endure the volatility. It’s not uncommon for stock prices to drop sharply every few years. Many of these declines can cause even the most patient long-term investor to question their position. So I don’t focus too much on the fluctuations in stock prices.
I like to focus on dividends because that is real money that is deposited into my account for the privilege of owning a stock. If I focus on the dividend and the dividend is well covered by earnings, then I can ignore short-term noise and negative news and try to focus on the long-term picture. This is difficult to do when your only focus is on stock prices, bad news, and facts when things go bad. And believe that as a long-term investor, you will experience a lot of turmoil in the decades that you invest. That is why you need perseverance that will convince you to stick to your investment plan through thick or thin. When you’re paid to own and hold stocks, it’s a nice reminder that you are persistent.
If you stay invested and aren’t afraid of short-term noise, you can enjoy compounding your money with high returns.
The chart below shows the price history, quarterly dividends per share and annual earnings per share for Johnson & Johnson (JNJ). While stock prices declined rapidly in 2000, 2002, 2008, 2015, 2018 and 2020, the investor who focused on the growing flow of dividend income could have captured and even capitalized on the price losses. When an increasing dividend is paid out every year, the investor has the inner strength to stay invested and even ignore fluctuations when, for example, he retires. This statement applies as long as the dividend is at least maintained. In the case of Johnson & Johnson, this dividend king has raised dividends for 58 straight years because he has managed to grow earnings per share over time. The dividend is also well covered by earnings.
The concept of staying power applies to pretty much everything else in life, by the way. When you enjoy your job and your career, you have staying power. You are more likely to be trying to do a good job if you enjoy your job. When you hate your job and are forced to work long hours for a difficult boss, you are less likely to stick to it.
Similarly, when investing in stocks, you have to be persistent. You should invest money that you do not expect for at least a few years. If you really need the money soon, you’d better put it in a lower-income fortune that doesn’t fluctuate in price.
If you focus on dividend income, which is more stable and easier to predict than stock prices, you can afford to ignore market volatility. The only way to look for problems is to find lower prices when you have money to deploy. Dividend income is easier to predict and more reliable than stock prices. In the past, dividends in the US have increased the rate of inflation faster. US companies tend to increase a dividend over time. Companies rarely cut or eliminate dividends.
This is to be expected for some cyclical companies, or companies that are on the verge of a permanent decline. Another example of massive dividend cuts will occur during an economic disaster like the Great Depression of 1929-1932 or the Great Recession of 2007-2009. Even during these two cloudy periods for US capitalism, dividends per share declined much less than stock prices. Dividends are more stable, reliable, and easier to forecast than stock prices. That being said, it’s pretty smooth sailing. And while we had more dividend cuts than usual in 2020 due to Covid-19 stoppages affecting businesses, the total amount of S&P 500 dividends hit a record high in 2020.
These characteristics make dividends the ideal source of income in retirement. In my retirement plan, I focus on the bottom line and structure my investment so that I can see immediate progress towards my goals. That’s why I’m focusing on dividend growth stocks.
When you receive dividends, you know how much you can safely spend. You have a smaller chance of running out of money in retirement if you focus on dividend investments. If your focus was on selling stocks to determine how much to spend, you would need the services of a math or economics graduate student who does complex formulas, statistical regressions, and Monte Carlo simulations. With dividends, it’s easier to budget and know how much you can safely spend in retirement. If you multiply the number of shares in each company you own by the expected annual dividend rate, you can easily see how much money you will be made over the next year.
When companies you own make money, they invest some of the time in growing the business and sending you the excess cash flow in the form of dividends. Dividends force companies to focus only on projects with the highest ROI. Dividends also reduce the likelihood that management will make heavy spending or attempt to build empires that enrich the CEOs at the expense of common stockholders. Patient shareholders get what they deserve: a four-yearly reminder that they, not the management, own the company. When these investors receive dividends, they focus on the companies’ long-term ability to pay and grow dividends. That ultimately gives them the patience to hold onto their stocks. Perseverance when investing in dividends is very important.
Dividends are an underrated form of return today. But that’s because few people really understand investing or have the knowledge or temperament to invest successfully over the long term.
– Dividend income is more stable than capital gains
– How to never run out of money in retirement
– Dividend investors should ignore market fluctuations