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Why Your Portfolio Should Only Consist of Dividend Stocks

07.10.2011 · Posted in Dividend Stocks

After investing in stocks for some time, I have come to a conclusion that I will only pick stocks which pay out dividends of at least 3%. Anything below that, you risk getting negative returns due to inflation. If you read my earlier post, I have discussed various Strategies for Stock Investment. Now I will elaborate more on why we should only invest in Stocks which pay consistent Dividends.

Returns Right Now

As the saying goes, a bird in hand is worth two in the bush, it is better to earn the income from dividend yield first than to wait for the price to go up. Either Growth or Value Investing both requires the price of the Stock to rise for you to receive gains. The trick is the 3 strategies are not mutually exclusive. A dividend paying stock could also be a Value Buy or Growth Stock. Why not look for an undervalued stock which also pays Dividends? Wouldn’t it be better to make money first while waiting for the price to appreciate? In fact, a Value Buy probably means the Dividend Stock is also trading at a high Dividend Yield. When we look at the Growth story, other than the rising revenues and profits, we also look at the potential growth of the dividends.

Long Term Income Stream

Buying a stock for its Dividend Payments also ensures a long term stream of income. Since you do not have to sell the Stock, the money making engine continues to make money for you as long as you stay invested. This of course is the most important, since our goal is to build Passive Income. Through compounding as explained below, we can also increase this income stream dramatically over time. Remember, Stocks are not static; they are organic organizations, as they grow, Dividends are also likely to be increased if the Company retains its pay-out ratio.





Compounding For Massive Growth

When you receive the Dividends in cash, you have the choice to either keep the cash or reinvest it. Certain companies also allow you to enrol into DRIPS, better known as Dividend Reinvestment Plans. DRIPS allow the Company to directly convert your dividends into more stocks normally at a discount to the current market price with no fees. It’s one of the best ways to maximize returns in a strong Company. Let’s say you buy a $10,000 worth of Stocks which pay out 5% dividend, you will receive $500 in dividends this year. If you reinvested the $500, it makes another 5% which is $25, bringing dividends this year to $525.  You reinvest the $525, which brings total dividends to $551.25. Simply put, you make more dividends on the dividends received, compounding and growing your value exponentially. Assuming all factors remaining constant, by year 20, you would be making about $1,200 in dividends a year versus $500 if you haven’t reinvested. By year 26, you would made 256% returns, almost double of 130% returns if you did not reinvest. That’s a pretty good return considering that you only invested $10,000 at the start and nothing else after!

Dividends Reinvested Yearly (Compound Interest)

Dividends Compounded YearlyDividends Not Reinvested (Simple Interest)

Dividends Not Compounded




True Measure of Performance

The standard measures of performance such as revenue and earnings can be manipulated and even faked. In the recent accounting scandals, many listed Chinese firms were thought to be overstating profits and even their cash balance! Dividends however, are real; once they are given out, its cold hard cash coming right into your pockets. Either they have it or they don’t. Companies which are not doing well will not be able to pay out good dividends year after year if they were not making good money. They would either have to pay Dividends out of dwindling cash balances or raise debt to finance the Dividend, neither of which is sustainable in the long run.

Unaffected By Short Term Volatility

Unfortunately, due to the way the market has transitioned, most people are almost entirely focused on short term price performance of the Stocks. The Stock exchange, the brokerage and your brokers make money by the number of transactions you make rather than on the returns you derive from the stock. Analysts are also focused on predicting near term figures and price targets to invoke reactions in investors to buy and sell unnecessarily. The result is an extremely volatile market which is driven by market rumours, breaking news, analyst reports which have no bearing on how much dividend you are receiving. The good thing is that you simply do not have to be too bothered by the price volatility, it’s something you learn to not take too seriously, while receiving your checks regularly.

With all those factors discussed above, I hope that you too will focus only on Dividend Stocks. If the market as a whole can place enough pressure on the Companies, we can force more Companies to increase Dividends rather than spend money on stock repurchases and unnecessary M & As.

 

For further reading, you may be interested in:

Dividend Basics

Dividend Stocks vs Gold

How to Pick a Top Dividend Company for Dividend Income Part 1

9 Responses to “Why Your Portfolio Should Only Consist of Dividend Stocks”

  1. Hi Calvin, thanks for the very informative and insightful materials posted on your blog – very beneficial to all who are interested in reaping stable investment rtns. I’d just like to enquire which listed co.s are known to have Dividend Reinvestment Plans (DRIPS) in place for their shareholders? Appreciate your help. Thanks.

    • Hi Weng,

      I am not sure about all of them, but I know the 3 major banks OCBC, UOB, DBS and certain REITs such as Cambridge REIT offers DRIP. My personal opinion though is to take the cash, it gives you more flexibility and you don’t get odd lots, which are more difficult to sell.

  2. Giuliano says:

    I like dividend stocks and ETFs. One of the important issues not included in the analysis are taxes. I live in a country that has no tax treaty with the US. So if I pay the withholding tax in the US anyway I will have to pay again in my country. But withholding tax are only in dividend and not in capital gains, so the benefit of dividends are diminished. I understand that in HK there are no taxes on dividends. Do you have any recommendation? Thanks.

    • Hi Giuliano,

      As a non US Resident, your US divdends will have 30% withholding automatically. Which country do you live in? In Singapore and Malaysia, you do not have to pay income taxes for income from foreign sources. Yes, the dividends are taxed unfairly while capital gains for US stocks are non taxable for foreign investors. This is a reason why dividend yields for US companies tend to be lower, also US companies suffer from double taxation, so there is even lower incentive to give out dividends.

      In Singapore, Malaysia and HK, the dividends are taxed at source on the corporate level. So the companies are giving out dividends after taxes. Therefore the investors do not have to pay income taxes.

  3. Hi Calvin
    I have read a lot about reinvesting & the compounding effect, however, imagine you hv one lot of sph, each year giving you sgd240 (assuming 24cts dividend), how to reinvest when the cost of the stock is much higher.

    Thanks for the advise.

    • Hi KG, when it comes to reinvesting & compounding, the assumption used is always that you reinvest at the same dividend yield rate every year. In reality however, that does not happen as the stock price moves constantly, causing dividend yields to change as well. If you just reinvest without taking into account the valuation, it may not be the best use of your dividends.

      I prefer to keep the dividends until a time where the dividend yields become more attractive before reinvesting. As the stock price usually trades within a band, it make sense to buy in at historically below average valuations.

  4. Hi Calvin

    Your articles are easily understood and comprehensive. I have an SRS account. Just wondering if you have advice for counters using SRS funds? Thks.

    • Hi Lynn, SRS account funds are very flexible, unlike CPF funds. You can invest them in stocks, bonds, unit trusts etc but my recommendation would be to invest them in dividend yielding stocks. That’s because CPF OA is restricted to 35% stocks and SA cannot be used to invest in stocks directly, only approved unit trusts.

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