August 7, 2018
This post was created partly out of frustration.
And partly to highlight a couple of powerful points to help keep you (and me) on track with our investments.
I’ve seen more than a few comments on other finance websites, that assume Dividend Investing is only for retirees and those who have already reached Financial Independence.
Also, that it’s obviously the much slower path to wealth, because capital growth is king. I don’t buy either of these statements. I think they’re a little misguided.
While it may be boring, I’ll show you why I think Dividend Investing is not just for the later stages of our investing. In fact, for those with a solid savings rate, I believe it’s the best strategy for reaching Financial Independence as quickly as possible in Australia.
Sometimes short-sighted people will point to the last 10 years of Aussie sharemarket returns, as to why this country is a crap place to invest in shares, regardless of the dividends or not.
Nothing exciting seems to be happening here. And we don’t have the high-flying tech companies the US has, regularly setting share price records and making us giddy from the wealth effect.
The mindset reeks of recency bias.
Because the US has been much stronger over the last 10 years, many investors think it’s the best place to invest. It could be a wonderful place to invest for a whole host of other reasons. But recent performance should not be one of them.
No argument, the US has recovered far better from the GFC than Australia. But we had a huge boom in the previous decade, while the US had fairly low returns.
So it needs to be put into context. Which market does better over the next 10 years is anyone’s guess. But history would suggest Australia has a slightly better chance (not that it really matters).
Sadly, some folks miss the point altogether and simply compare where the market was before, and where it is now.
Comparing a price index, or just the ‘value’ of an investment only tells half the story. But many times I’ve seen a comment like the following…
‘If you had invested $100,000, 15 years ago, your investment would only be worth $x’
Maybe because we obsess over house prices, so we think the ‘value’ of assets is all that matters. As a result, perhaps we drag this mindset over to the sharemarket.
Let’s look at an investment of $100,000 and we’ll assume reasonable capital growth of 4% per annum.
So in this case, while the investment doesn’t sound (or look) like it’s done much, the investor is not too far away from doubling their money. The $100,000 turned into $180,094.
But this is only what the investment is worth, which in my view, misses the whole point of investing in shares. Dividends!
What’s this investor doing with the cash dividends he’s receiving? Spending it at the pub? Donating it to charity? I don’t know. But it’s insane not to include the cashflow in an investment calculation.
Now here’s what the investment return looks like when we (correctly) include dividends.
This time, $100,000 more than tripled, turning into $317,217. Now we’re getting somewhere. This is the power of reinvesting your dividends.
But somehow even this doesn’t feel like a good real-world example. Especially for us.
Since most of you, my readers, are striving for Financial Independence, your progress is going to look radically different to this.
Why? Well, because you’re not investing a stagnant $100,000. You are living efficiently, saving regularly, and constantly adding to your investments. After all, how else will you reach FI!
Rather than leave that lump of cash to work by itself, we’ll assume you keep adding to your investments, to the tune of $40,000 per year.
For those unhappy with the starting balance, if you start from $0, the end balance still becomes over $1 million. Actually, $1,086,000 to be more precise.
This is a much more realistic view of what readers around here could expect when looking back at their portfolio after 15 years. Of course, the sharemarket doesn’t move in a straight line like this. Far from it.
But the point is, to just look at share price movements and the ‘value’ of an investment, is missing the point.
Now let’s look at the results all together…
The vast majority of wealth in this scenario was created by adding regularly to the portfolio.
Even with lower investment returns, the result won’t change much. That’s because most of the wealth created in a 10-15 year journey to FI, comes from saving.
So even in a slow-moving sharemarket, you’ll still be making massive progress.
In addition, dividends are an incredibly important part of returns over the long term. This is more true in Australia than almost anywhere. So to ignore the power of reinvesting dividends is batshit crazy.
OK, so this goes for all sharemarket investors. What’s it got to do with a dividend investor?
Well, these chart examples simply look at the ongoing value of the portfolio. Yes, the example uses reinvested dividends and extra money added. But around here we do things a bit differently.
Rather than focus on the ongoing value of the portfolio, there’s another, more suitable way, for us to look at the portfolio’s progress. Income. That is, how much cashflow it spits out each year!
If you’ve been reading for a while, you’ll know I believe in investing for rising income, rather than rising asset prices.
As an investor, I prefer this strategy because it means investment success is more closely tied to the much less exciting, but more meaningful, company profits and dividends. Not to the endlessly talked about, but largely irrelevant, market movements.
This goes for whether I was starting today from zero, or I had $20 million in my brokerage account. Of course, with a massive amount of money, it’s more tax efficient to invest for a lower yield, with higher income growth.
For Aussie investors, I took a look at the yield/growth trade-off in this post.
Ultimately, I’m far more interested in the income from a portfolio, than the value of a portfolio. So here’s how StrongMoney would look at the early retirement journey starting today.
We’ll assume the portfolio starts at zero, $40,000 per year is added, and returns are 8% p.a – consisting of 4% dividend yield and 4% dividend growth.
This shows exactly how I would measure my progress.
It doesn’t matter what the portfolio is worth. The share prices will follow the earnings and income stream over the long term anyway.
After 15 years, the portfolio now throws off over $43,000 in dividend income per year.
And under current rules, assuming those dividends came with 100% franking credits, this would boost the income to around $62,000. Split between a couple, there would be very minimal tax to pay.
This is just an illustration, I can’t break down every scenario of returns, incomes, savings and tax rates into a smooth and concise blog post!
In practice, the progress with this approach is likely to be far less erratic than the other approach as measured by portfolio value. This is because dividends don’t move around anywhere near as much as share prices do.
In fact, you don’t even need to look at the value of your portfolio. Let’s simplify the investment process.
First, decide where you’d like to direct your investment capital.
Some of you might choose the LICs for the smoother, more predictable income profile, despite the risk of underperformance. Maybe even a combination of both.
Next, buy a parcel of shares! Don’t wait for the price to drop 2 cents to get it cheaper. Just buy the damn thing!
And next month, or the one after, when you have a wad of cash saved up again, repeat the process.
After this, you’ll receive a couple of dividends throughout the year. I must warn you though. It will feel slightly magical. You’re getting paid regularly to do nothing. Be careful, it can become addictive!
Of course, this extra cash isn’t for pissing up against the wall. Not yet anyway. Right now, it’s for buying more shares!
Reinvest the extra cash into your chosen index funds or LICs, while you keep adding regular savings to buy more.
— Every time you buy shares, your Annual Dividend Income goes up.
— Every time you reinvest your dividends, your Annual Dividend Income goes up.
— And every time Australian companies increase their dividends, your Annual Dividend Income goes up.
— Any time one of these things happen, your financial position becomes stronger and stronger.
This is the relentless progress of a Dividend Investor!
All of these factors are working in your favour, to bring your Financial Independence closer and closer. What could be more motivating?
Forget share prices. Focus on your growing annual income and the quantity of shares you own.
So why do I like this approach so much?
Because your passive income stream and reaching financial independence is overwhelmingly driven by your own efforts, plus business performance, rather than dictated by the mood of the sharemarket.
By measuring progress this way, you’ll be moving forward almost constantly, to a goal that edges ever closer.
And don’t worry about whether it’s a good (or bad) time to buy.
Just focus on constantly increasing your ownership in a large group of businesses. This means your slice of the pie gets bigger with every single purchase.
No matter how small it might seem, your stake is genuinely growing. In real companies, that provide goods and services, here and overseas, as well as creating new products and operating valuable infrastructure.
Looking at the ‘market’ too much, we tend to forget these things. But it pays to bring our minds back to basics to remember what it’s all about!