FOR THE PAST 20 YEARS, I’ve bought dividend-paying stocks and then reinvested my dividends. The big appeal: I increase my wealth with minimal effort.
Starting as a dividend investor used to be tricky, but it’s now much simpler. Many discount brokerage firms have no minimum to open an account and no longer charge stock commissions. You can also purchase shares through the dividend reinvestment plans offered by the transfer agents for many companies. These plans allow shareholders to reinvest their dividends and also purchase shares in amounts as little as $50 or $100.
Indeed, when I buy dividend stocks, I usually set them to “dividend reinvestment.” That means I don’t get my dividends in cash, but instead use them to buy additional shares. That way my share count—and the dividends I receive—increase automatically.
Of course, there are thousands of companies you could potentially invest in. Which should you choose? First, I avoid companies that don’t pay dividends. Second, for those that do, I look at their track record. Did they cut or eliminate dividends when the going got tough? How long have they been paying dividends? Do they have a history of increasing dividends over time?
In addition, I avoid companies that are in the news a lot. I prefer companies that are almost boring, that have been around a while—companies that are likely to have staying power. We’ve all seen how technology has replaced prior methods of doing things, and we know that’ll continue. It just isn’t easy to know what those changes will be. Financial history is full of once-successful companies that have since ceased to exist. How can investors protect yourself?
I know my choices won’t be perfect, which is why I buy shares in different companies in different industries. Some companies will fail or falter, even though at one time they were seen as very strong—companies such as Kodak, Sears and General Electric. But over the long term, my investments in those companies that thrive will more than make up for those that don’t.
Today, I own shares in stalwarts such as Johnson & Johnson, Colgate-Palmolive and Procter & Gamble, and some not-so-well-known names like RPM and Emerson Electric. No, I’m not recommending you buy these particular stocks—they’re just five of the 60 stocks I own. Among those 60, most I chose to buy, but a few of my holdings were the result of spinoffs or acquisitions by other companies.
Instead of buying individual stocks, you could purchase funds such as iShares Core High Dividend ETF (symbol: HDV) and Vanguard High Dividend Yield ETF (VYM). But I prefer individual stocks because I get to choose the companies myself.
Intrigued? To succeed at dividend investing, you need just three things. First, you need some initial capital. Second, you need to identify the companies you want to own and decide what to do with your dividends. Do you want income now or do you want to let the dividends buy more shares?
The third thing you need is time. Your income from a diversified collection of dividend-paying stocks should grow over time—and more time means more growth. The earlier you start, the more time you’ll have not just for your companies to raise their dividends, but for you to buy more shares by reinvesting dividends and by investing new savings.
That’s it. It isn’t magic. Getting started is the hardest step. But once you’ve gotten over that hurdle, things should just grow and grow.
Joe Springer is retired and lives in California. He likes oatmeal, gardening, taking a morning walk and laughing at his own jokes. Joe is the author of the blog Smile If You Dare, where he tackles money, retirement and other topics.
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Although buying dividend paying stocks has been my strategy for years and years I’m not sure it makes sense to limit one’s investing choices solely to these companies. This may be particularly true given the rise in popularity of stock buybacks.
However, I like the site ‘simply safe dividends’ for info own dividend paying stocks.
Great article and one more reason to hold these dividend stocks is their stability. I hold about the same amount of individual stocks as well and they are the “aristocrats” also. They have been much less volitile than the indexes and help me SWAN. Some of you may have read Ryan Krueger, he is another proponent of dividend stocks and if you are retired and can get your portfolio yield >4% then the 4% rule works – mine is very close now and I constantly try to improve. Read this great article from Ryan.
https://www.freedomdaysolutions.com/post/whoa-what-if-there-isn-t-a-safe-withdrawal-rate
There is no reason to believe the 4% rule will work in the future, and especially so when using only dividend stocks, instead of a more broadly diversified portfolio. Even Bill Bengen doesn’t use the 4% rule that he invented.
I like companies that pay steady dividends. It usually shows that they are well run and can compete in the marketplace.(You can usually see the poor performers who hide behind dividends.) One can get more “pop” with growth stocks, but you’d better know what you are buying. You still need to diversify, which is what funds offer. The downside of having a dividend-paying portfolio (outside of an retirement account) is that you will have higher taxes each year, directly and through those insidious enhancers, like the Medicare MAGI/IRMAA premium add-on, and some states’ phaseouts of Social Security tax exemptions. Still, I think you sleep better at night.
Good article, Joe. Thank you for taking the time to write it. Compounding your portfolio with dividend reinvestment is a great strategy and I’m sure most Humble Dollar readers agree.
You state that you avoid mutual funds because you prefer picking stocks yourself. That means you spend a fair amount of time doing your homework. Not only do you research companies so you can choose the best ones for investment, but you also have to spend time monitoring the companies in your portfolio to make sure they are not facing potential headwinds.
Do you feel that maintaining a portfolio of 60 stocks is something you can continue to do as you age? Do you foresee a time when you might invest in dividend-paying mutual funds so they can do the heavy lifting?
May I suggest Vanguard Dividend Growth- who’s goal is purchase holdings that can grow their cash distributions in the coming years, or Vanguard Dividend Appreciation- who’s goal is purchase holding that have increased their payouts consistently for at least the past 10 years, screens out less profitable companies, and those with deteriorating fundamentals? These funds will spread your risk, without the hours of research, the hoping you got it right.
I have nothing against dividends, but I am not driven by either dividend paying companies or those that don’t and reinvest their cash flow. What is important is the total return expected whether as capital gain or dividend. Dividends aren’t free money. If a stock is at $100 and it pays out a $2 dividend the immediate new value is $98. If in an IRA and reinvest you still have $100 of that stock. If in a taxable account you have $100 less any tax paid on the $2. Like others have commented, I in my younger years used to reinvest using DRIPS or otherwise as it was a low cost way to put the dividend back to work. As others have pointed out however, investing fees today are usually not a cost driver any longer. Tax treatment is my driver.
If I need cash flow(retired and in my 70s) I don’t reinvest dividends in a taxable account. If the investment is in a tax differred qccount I generally do reinvest dividends automatically to keep the cash invested, and when I need cash just sell some shares – most of investments are in funds so fractional shares to get whatever I need is easy.
Berkshire is a great company (doesn’t pay dividends) as are the dividend paying ones mentioned – I have no problem with investing either. My decision is where to invest in a dividend paying company(or fund) vs a no/low dividend paying company(or fund) – IRA or taxable account.
I agree …. up to a point. There are problems with high dividend stocks, too:
That said, I too like having dividends as a big piece of my strategy. Almost without my heavy steering dividends (pre-tax) would cover 68% of my spending this year. Post-tax (see point 2) a fair bit less!
I’m not a dividend-focused investor but I respect your approach, as it’s clearly something you’re committed to and you seem to be tracking your benchmarks to those high quality Dividend ETFs. I’m sure you have a lot of good opportunities to tax-loss harvest as well.
Everyone has their goals, timelines and risk tolerance. I would imagine, though, if still investing for retirement, stocks with dividends reinvested makes sense and and allows switching “on” dividend payouts if needed during retirement, when income taxes usually drop. I like index funds, though, because they have low fees and are diversified across many stock classes that do best in different time periods. My retirement fund offers Vanguard Primecap, an active, low cost fund that has averaged 13% for over 35 years. It averages 1% above the S&P 500 index funds and is followed in Vanguard performance rankings by small and mid cap index funds — I sweeten a total index fund core with these with additional boosts during big stock downturns.
BUYING Individual stocks is a guaranteed losing game long term.
NOTHING beats indexing, be it S&P 500 or Total Stock
Why waste time?
It is not a guaranteed loser as I have been investing in individual stocks for 30 years now and have a pretty good track record with about 60 or so stocks and as Joe said they are companies who increase their dividends every year and have done for a decade or more. Another reason to hold blue chip dividend stocks (not high yield as has been commented on here) is they are much more stable and do not decline as much as the indexes do. I can control what I own, I have no control over the S&P or any other mutual fund or index and I can control what I sell. Mutual funds are notorious in giving you a bunch of capital gains in Oct of each year as they try to hold on to their performance and bonuses. Ryan Krueger writes a good blog about this as well. If you are retired or close to it, it would be a good article to hold on to. I assume you have heard of the 4% rule. https://www.freedomdaysolutions.com/post/whoa-what-if-there-isn-t-a-safe-withdrawal-rate
I’m a huge fan of indexing and I don’t own any individual stocks. But even as a committed indexer, I would never claim that “buying individual stocks is a guaranteed losing game long term.” I don’t think it’s an optimal strategy, but some folks who hold individual stocks will indeed do better than average over the long term.
Could you clarify which average you were referring to when you said that some individual stock investors do better than average over the long run? Better than the average index investor? Better than the average S&P return? Better than what one did expect by chance?
If you are well-off, you may not want to maximize returns. I am retired, well-off, and happy to keep up with inflation. The stock market has big ups and downs. Recently, six large tech stocks have been 30% of the S&P 500. When tech stocks ran into trouble, the index went down.
My dividend growth portfolio is actually up 3% for the year, and I am getting more dividend income than ever. If you are retired, what’s not to like? If you’ve got a portfolio of at least $2 million, you don’t need a big capital increase every year. I do less well when the market is in a boom, but very well when it crashes.
It’s even simpler than that. If you have a dividend growth portfolio that covers your expenses, you don’t need to own bonds. That bumps up your long-term returns.
If there are dividend cuts (which are often temporary with stable long-term businesses, as in 2008), you cover the difference with Social Security or a pension. The ability to stay invested in a down market without selling shares for income is priceless.
Pick whatever index you want. Before costs, investors collectively will earn results equal to that market average. After costs, most will lag behind. But not all. If all investors were ***guaranteed*** to lag behind the market average, only the certifiably insane would try. Should we declare that all buyers of individual stocks are insane? For index funds to work, there must be active investors — and they must have some hope, however slim, of succeeding.
I agree that there will be many individual investors who beat the market average over the short run and that active investors wouldn’t try to beat the market if this wasn’t the case. However, as is the case with lotteries and casino gambling, I don’t think your reasons necessarily hold up when it comes to active investors versus indexers over long time periods, which is what is the relevant time frame for most of us. As is the case with gambling, as long as there is a realistic possibility of winning big, large numbers of people will play the game regardless of the long-term odds of success.
Given the large presence of institutional investors, is your statement that some individual investors do better than the market average over the long run necessarily true?
All we can say for sure is that some investors — a minority — are outperforming. Individuals have the advantage of no management fee. Does that overcome potentially less competence? I don’t believe the data are available. Do you have conclusive evidence one way or another?
While we can say for sure that some investors are outperforming, I am unaware of any evidence that that number is greater than what would be expected by chance. Is there evidence that I am unaware of?
I recommend reading ‘The Big Short’ by M. Lewis. I think it provides an interesting take on this issue.
I’m not quite sure why you’re so persistent in your line of questioning, but let me again state my main point: Even as a committed indexer, I would never claim that “buying individual stocks is a guaranteed losing game long term.” Some folks — a minority — will outperform. Is it skill or is it luck? I tend to believe it’s mostly the latter, but can’t say for sure. Is the number large or small? I know it’s a minority and it’s probably a small minority, but I can’t say for sure. Does any of that justify your persistent questioning? It’s starting to seem a tad odd.
Since all stocks are held by someone, the total holdings of all stockholders must equal the total return of the market.
Since some stockholders have lesser returns than the overall market, some of them must be doing better. There are no longer any costs to buying stocks, commissions are $0.
That’s not quite true: Bid-ask spreads will put a dent in returns — especially with smaller-cap stocks and individual bonds — and, of course, many folks also incur fund expenses.
Great article Joe. I was a big fan of DRIPs in my early investing career. They were a great way to get started when we didn’t have a lot of excess cash.
I too like dividend stocks in addition to my index funds. I especially like many of the 65 dividend aristocrats:
https://money.usnews.com/investing/stock-market-news/articles/dividend-stocks-aristocrats
Note that VYM has outperformed the S&P 500 for the last one and two years, but is well behind for the last five and 10 year periods.
As a value fund, VYM’s strong recent performance — and weaker returns over 10 years — are no great surprise.
I often thought dividends could provide a steady income stream in retirement. I hold only two individual stocks, one only a few hundred shares and the other several thousand which I began acquiring many decades ago through a employer stock purchase plan at $10.00 a payday and then as part of my compensation.
You seem to carry the dividend thing to a new level. You must enjoy the selection and monitoring process. It seems a lot of work unless it’s fun as well. In effect, you are running your own income focused mutual fund.
Do dividends form a significant portion of your retirement income?
I own 55 dividend growth stocks that cover all my expenses. Once I select stocks, I don’t look at them ever. I do not intend to sell. I simply hide the rows on my spreadsheet and update the share count once a year. My dividends have grown at a healthy rate and I don’t panic or sell in down markets because I focus on the income rather than stock price. I do not reach for yield and my portfolio has outperformed the S&P 500 over the past decade.
I’m with you, about 3/4 of my portfolio is in dividend stocks.
Be prepared for feedback from the growth investors and the ever-militant index fund investors.
I had to laugh when I read this reply. Having a dividend focused stock portfolio or holding individual stocks period is definitely a minority view on this site. Most of my portfolio is in dividend stocks and while I’m not a buy and hold forever investor, I don’t trade very often and I don’t chase yield. I’ve had a few stocks over the years blow up in my face, but I would never let one or even a few holdings represent too large a percentage of the total. I think there’s more than one way to reach your financial goals and it works for me. Having an accounting and finance background, I enjoy it as well.
There are probably more dividend investors on the site than you might think. I also have a large portion of my investments in dividend stocks, and it pays me better than SS.
Excellent reminder why boring is good. Favorable tax treatment too.
this is investing. Sharing the profits of companies, not speculating on buying low and selling high!