Thursday, September 10, 2015

The Predictability And Practicality Of Dividends

In light of some recent minor volatility in the stock market, I thought now would be a great time to revisit the very nature of dividend growth investing and why it’s such a robust strategy for those aiming to one day live off of their growing dividend income.
Now, there are a number of really attractive qualities that dividends feature that make them so wonderful in the first place.
But today I’m going to discuss two great qualities that, in my view, really shine through when the Mr. Market is moody.

Dividends Are Predictable

If someone were to ask me what The Coca-Cola Co.’s (KO) stock price is going to be tomorrow, next week, or next month, I’d have no idea. Could be $39 per share. Could be $41 per share. Or more. Or less.
So what are the odds that I’ll know beforehand what KO will be priced at on October 1st, 2015?
Zero.
But if you were to ask me what Coca-Cola’s dividend will be on October 1st, 2015, I’d know with 100% certainty that they’ll pay out $0.33 per share.
And I’d also know that the odds are very, very strong that Coca-Cola will pay out that same $0.33 in mid-December.
Even better, the odds are also strong that the company increases that $0.33 at a rate above inflation in time for the payment in early April. So that means shareholders can look forward to even more than $0.33 per share next spring.
That’s predictable.
I can basically see into the future by having some certainty in regards to what kind of income my investment will provide me.
It’s that juxtaposition – constantly oscillating stock prices compared to very predictable dividends – that attracts me so strongly to the idea of one day living off of my growing dividend income.
That predictability of dividends works incredibly well in real life, especially in light of the stock market’s behavior recently – behavior that will likely repeat itself every so often over and over again.
And the reason why that predictable nature is so fantastic in real life is because our fixed expenses are also predictable to a large degree.
I know when rent is due and how much it’ll cost me. My mobile phone bill is $25 every month. I have a pretty good idea of how much I’ll spend on food. Internet runs me about $27 per month. So on and so forth.
As such, it’s easy to line up my dividend income with my expenses.
We can all see that I earned $410.52 in dividend income last month. And we can compare that to the$1,745 I had in personal expenses for July. So that means I was able to cover over 23% of my personal expenses via passive income alone.
However, we can also glean two additional key pieces of information here.
First, if I really wanted to, I would have been able to predict that $410.52 ahead of time. I could say to myself in June that I was going to earn more than $400 in dividend income in July. That makes planning for expenses very easy, especially once dividend income is the primary/only source of income down the line. Makes budgeting extremely easy.
Second, I had a very high degree of confidence that I was going to collect that dividend income regardlessof the stock market. The market could jump by 5% or fall by 5% and it wouldn’t matter at all to me in regards to what my dividend income was going to be.
This is important once I’m financially independent and actually living off of the dividends my portfolio generates. After all, who wants to worry about stock prices when they’re busy traveling the world, or spending time with loved ones, or pursuing passions? I’d rather just let the dividends roll in and go about my life.
The reason I was so confident beforehand that I was going to collect that income, regardless of the market, is because there’s a second juxtaposition at play here.
A dividend is paid to me as a shareholder directly from and by a respective company. The board of directors at Coca-Cola, for instance, determines my dividend from the KO stock I own. And it’s the profit/cash flow the company generates that determines the board of directors’ ability to pay and increase its dividend to shareholders. So as long as Coca-Cola is earning more money over the long run, my dividend from the company should continue rolling in and growing.
The flip side of that coin is stock prices. Stock prices are absolutely not determined by a company’s board of directors. They’re determined by external forces, supply and demand, rumors, noise, millions of traders buying and selling every millisecond, and robots looking to take advantage of technological advantages, among many other factors.
So would I rather bet my financial independence on robotraders and rumors or Coca-Cola’s ability to sell more Dasani water, Coca-Cola, and Simply Orange to millions of people around the world while simultaneously slowly increasing prices over time?
Indeed.
I can tell you that my portfolio oscillated by more than $15,000 in market value over the last week or so. And we haven’t even really seen that much volatility recently.
But what happened to my dividend income? What happened to the actual number of shares I own in the broad collection of businesses I’ve assembled?
Nothing at all. $15,000 in aggregate stock market value can come and go, but the dividend income tends to just keep on coming.

Dividends Are Practical

One other major reason I love the idea of living off of growing dividend income rather than slowly selling off my portfolio and chopping down my money tree is the practicality of dividends.
The thought of selling off a predermined chunk of your portfolio every month, quarter, or year might not seem like such a bad idea when you’re 40 or 50 years old. But what about when you’re 70? Or 80? or 90 years old? Do you really want to track withdrawal rates and inflation for the rest of your life? Where was I at? 5.2% last year? Okay, inflation is 2% this year… That puts me at… I’m lost.
I suppose a lot of that depends on how mentally sharp you are once you’ve advanced in age, although I’d argue that a year definitely isn’t a year.
But I guess you’d have to ask yourself which you’d rather rely on in old age: dividends or the value of your portfolio?
If you’re going to live off of your investments for decades, your odds of experiencing multiple bear markets increases dramatically. What if you experience one when you’re 80? Do you really want to be thinking about how long your money’s going to last, what kind of adjustments you might have to make to your withdrawal rate, and what the stock market is up to?
The practical nature of dividends extends out living off of them in old age, in my opinion.
Dividends are simply deposited into my brokerage account. I don’t have to do anything for that to happen. I don’t have to follow the market. I don’t have to sell stocks. I don’t have to worry about robotraders and rumors.
And if you’re able to put yourself in a position where you’re living off of growing dividend income at a young age, you have wonderful odds that your snowball will start to roll away from you and create so much passive income that you couldn’t possibly spend it.
If you start living off of, say, $20,000 per year in dividend income at 40 years old (more or less in line with my personal long-term goal), you can assume (using the rule of 72) that dividend income will roughly double every decade if the dividends are increased at a 7% annual rate in aggregate. Based off of my numbers and the long-term numbers of the blue-chip stocks I track and invest in, that seems pretty reasonable to assume. So that means you’re looking at something like $40,000 per year in dividend income at 50. $80,000 in dividend income at 60. $160,000 in dividend income at 70. $320,000 in dividend income per year at 80. Compounding at its finest.
So I guess you look at that and you think about the practical nature of generating income without worry or input, and what I see is a problem where I’m 80 and probably can’t figure out how to possibly spend all of my passive income.
Would I rather worry about actuarial tables and whether I need to adjust on the fly at 80 years old or how I’m going to spend all of my money? Moreover, who cares what stock prices are doing when you have hundreds of thousands of dollars coming your way without having to lift a finger?
Now, a dividend cut or two or three could surely pop up over time. And a company or two could even possibly go sideways or bankrupt on you. Especially when we’re talking about decades here.
But like I’ve discussed before, diversifying your portfolio out over a few dozen or more high-quality dividend growth stocks means that even income loss from a dividend cut or two will quickly become rectified by dividend raises from the other stocks in the portfolio. Furthermore, an investor’s income is not only quickly made whole once again when one has many other companies increasing their payouts, but that income actually increases shortly thereafter. And that’s before factoring in the strong odds that the companies that temporarily experienced enough trouble to cut their dividends later reinstate them at the full amount.

Conclusion

Volatility doesn’t bother me at all. I look at short-term volatility as a long-term opportunity – providing me a chance to possibly buy high-quality assets for less than they’re worth. I don’t view volatility and risk as synonymous.
But volatility bothers me even less when I realize that the dividend income I’ll be living off of is predictable and practical. My portfolio may have swung by well into the five figures over the course of a few days, but my growing dividend income was completely unchanged – stock market volatility and dividend income volatility are also not synonymous. Insofar as it relates to my journey, progress, and success, it’s like the recent volatility didn’t even occur other than to provide cheaper stocks for my current capital.
I feel wonderful knowing that my growing dividend income is completely independent and detached from oscillating stock prices. My ability to achieve financial independence relies on the underlying performance of real-life businesses selling real-life products and/or services – which will fuel growing dividend income – rather than what millions of people and electronic programs think my tiny slices of businesses are collectively worth at any given moment. And I like my chances when I look at the likes of Johnson & Johnson (JNJ)Union Pacific Corporation (UNP)PepsiCo, Inc. (PEP), Walt Disney Co. (DIS)Visa Inc. (V),Chevron Corporation (CVX), and W.P. Carey Inc. (WPC).
My dividend income is almost as predictable as my expenses, and they’re certainly as tangible. That tangible and predictable nature makes it very easy to determine exactly how financially independent I am at any given moment, and where I am along the spectrum of freedom. In addition, I don’t need to worry about the stock market and stock prices and what all of that means for my portfolio value and what I’m able to withdraw at any given time. My rent doesn’t have an electronic ticker that oscillates daily. As such, it’s attractive to rely on an income source that is similarly predictable.
Even better, the dividends are quite practical, meaning that I’ll have less and less to worry about precisely as I potentially become less and less able to handle major financial concerns. If my largest financial concern at 80 years old is how I go about spending $300,000 per year in dividend income, I think I’ll be able to make it.
Full Disclosure: Long all aforementioned stocks.
What do you think? Do you find the predictable and practical nature of dividends attractive? 
Thanks for reading.

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