I have been investing in the stock market since my early 20’s but didn’t get serious with dividend growth investing until 2010. Over the last 12 years, my wife and I have made significant progress with our dividend portfolio and our dividend income. As many readers may know, it is our goal to live off dividends in the near future.
Dividend investing is just one of the many different types of equity investment strategies. Outside of dividend stocks, there are passive index ETFs, active ETFs, value stocks, momentum stocks, growth stocks, speculative stocks, and options, just to name a few.
Just to be clear, while dividend growth investing is the core of our investment, we do invest in other things such as index ETFs and growth stocks. For example, we own XAW for geographical and asset diversification purposes and we own non-dividend paying stocks like Amazon, Google, and Tesla.
So why do we invest in dividend growth stocks? What makes dividend growth stocks so attractive? Here are seven reasons why dividend investing works for us.
Dividends reinforce buy-and-hold
In my younger days, I did my share of short-term and momentum trading. Essentially I was trying to time the market, hoping to profit from it. But short-term trading was exhausting both physically and emotionally. I was sucked into monitoring and thinking about the stock market constantly.
After investing in dividend stocks, I found that I was able to remove myself from the emotional side of investing. Regular dividends helped me to stay on course and reinforce the buy-and-hold mentality.
If the stock market is firing on all cylinders, I’d just shrug my shoulders and continue with the dividend investing strategy; if the stock market is in beetroot red, I’d also shrug my shoulders and carry on with the dividend investing strategy. And anyone who tells you that he/she can accurately what the market will do in the short-term is either lying or is delusional.
Get paid regardless of what the market is doing
Assuming the dividend payments are safe, the beauty of dividend stocks is that you get paid regularly regardless of what the market is doing. Canadian banks like TD, Royal Bank, and Bank of Nova Scotia have been paying uninterrupted dividends since the late 1800s. Sure, these banks may not raise dividends each year and some may have cut dividends in really tough times, but the key is they have continued to pay dividends to shareholders uninterrupted for close to 200 years.
On the other hand, imagine owning non-dividend-paying stocks like Shopify or Tesla. When the share price is going up, all is well. But what happens when the share price goes down and you’re in the red? If you sell, you’ll have a realized loss. If you continue to hold, you don’t get paid and all you can hope is for the share price to recover eventually.
Case in point.. before the financial crisis, I purchased shares of ING Canada (now called Intact Financial) and Manulife. When the stock market was down the toilet in 2008, at one point I was looking at a paper loss of almost 50% for both ING Canada and Manulife. Rather than sell both stocks and take a big loss, I held onto both of them because they were both paying dividends with a reasonable yield.
I continued holding onto ING and Manulife and kept seeing dividends getting deposited into my account. Thanks to these regular dividends, I told myself that I could afford to wait for the share price to recover.
Now over a decade later, we are still holding both Intact Financial and Manulife. We are seeing sizable paper gains for both stocks but most importantly, both have continued to raise dividends in the last 17 and 8 years respectively, resulting in a solid yield on cost.
This wouldn’t be the case if I had purchased Air Canada back just before the financial crisis. Assuming that I continued to hold Air Canada shares through the tough times, I wouldn’t have recovered from my initial investment until around six years later. And I wouldn’t have gotten any regular payments from Air Canada during these six years. I’d consider that a major opportunity cost.
Dividend investing is easy to understand
Dividends are distributed from company profits. Therefore, when a company distributes dividends that typically means the company is well-run, already reinvesting profits back into its business, and is sharing part of the profits with its shareholders.
If a company is not profitable, it won’t be able to keep paying dividends. This makes the screening process quite easy and straightforward. More importantly, it allows for easy-to-understand analysis.
Take TD for example. TD distributes regular dividends every quarter and has been raising dividends for 11 straight years at a 10-year dividend growth rate of 9.2%, making it one of the best Canadian dividend stocks.
What is TD’s business model? I think it’s very easy to understand – it’s about securely holding and storing money for its clients while generating revenues by loaning out money and providing financial advice and products.
Keeping up with inflation
There have been a lot of talks about the rising inflation rates. People are worried, what would they do if inflation keeps going up? How are they going to afford essential items?
Many companies that pay out dividends aim to raise dividend payout each year. After raising dividends consistently, some companies eventually get coveted titles like Dividend All-Stars, Dividend Champions, and Dividend Aristocrats.
The key is that as long as dividends continue to grow over time above the inflation rate, investors don’t need to worry about the decrease in purchasing power.
A growing dividend income without having to ask for a raise? Gotta love that.
Building our own index ETF
By owning a collection of individual dividend paying stocks, we’re essentially building our own index ETF, rather than relying on someone else to pick and choose for us and having to pay management fees each year. If you look at our dividend portfolio, you’ll notice that we own many of the same stocks that the big index ETFs own, stocks like Royal Bank, TD, Bank of Nova Scotia, Enbridge, and Manulife, just to name a few.
Furthermore, when we are living off dividends, we don’t need to continue to pay the management fees each year. Our dividend portfolio generates money automatically for us without us having to pay any fees at all. This is one of the key reasons why we don’t own Canadian dividend ETFs.
Dividends are very tax-efficient
In the past, I have analyzed the tax efficiency of dividends and I have concluded that we can live off dividends and pay almost no taxes. In fact, Canadian dividends are very tax-efficient in non-registered accounts.
Just how tax-efficient are dividends? Here in BC, you can receive up to $50,197 of eligible Canadian dividends without paying any taxes. On the other hand, if you were to make $50,197 in working income, you’d be taxed at a marginal tax rate of 22.70%.
Some might argue that capital gains are even more tax-efficient than dividend income. Yes, I agree, but that means you’re selling your assets, whereas dividends are regular distributions without having to touch your principal.
By utilizing dividends instead of selling and withdrawing from your portfolio, you give yourself more flexibility and some margin of safety. To me, that is important.
Our money works hard for us so we don’t have to
My favourite part about dividend growth investing is that once we purchase a stock that pays dividends, we can just sit back and wait for dividends to be deposited into our accounts. Our money is literally working hard for us – so we don’t have to.
If we were to receive over $36,000 in dividend income for 2022 that means our dividend portfolio would generate $98.63 for us every single day regardless of what we are doing.
Can you imagine getting paid almost $100 a day without lifting a finger? I can!
Summary – Why dividend investing works for us
Above are just some reasons why Mrs. T and I love dividend investing so much. I could probably list more reasons like the ability to reinvest dividends each month and dollar cost average, reducing the beta/volatility of our portfolio, and avenues to improved asset allocation to our portfolio but I decided not to.
As mentioned, while dividend growth investing is our core investment strategy, we do invest in index ETFs and growth stocks as well. We consider ourselves as hybrid investors – invest in both dividend growth stocks and index ETFs; we only hold growth stocks with less than 5% of our overall portfolio value.
Please note that dividend investing may not be for everyone but I think it is a great choice for those that want to do a bit more than index ETFs.
Dear readers, why do you like dividend growth investing?