Listening to people with different opinions is always a good chance to learn something. I recently had a very constructive discussion with a fellow investor on Facebook and had the age-old “dividend investing or growth investing debate”. As the title of this post describes, I personally prefer dividend investing and I answered each question the best I could. The answers ended up being longer than my average blog posts so I thought I might as well posting it here as well.
Here I will give my personal views on these 3 questions.
1. Why I don’t include non-dividend growth stocks
2. Why I don’t prioritize greater rates of return
3. Why I choose to retire off dividends over the traditional 4% rule
1. Why not include growth stocks?
This is a common argument against dividend investing, but I think it comes down to how you want to use your money. To me, achieving a high total return and building your portfolio up to a few million dollars means little if you are going to just let it sit there (even if its growing). Especially if it doesn’t produce any cashflow.
Money becomes meaningful when you actually use it. Unlike dividend stocks, the only way to produce cash flow from growth stocks are to sell them. In addition to the difficulty of selling individual holdings, you will have less and less ownership of that company.
In my humble opinion, capital gains only feed the ego and that itself doesn’t provide much. Cashflow is what provides direct value to ones life.
Also, I currently run my own side business where I am currently making roughly 30-40% ROI, which is higher than the total return of most growth stocks. Personally, I would rather invest in myself rather than growth stocks if I wanted to grow my capital faster.
2. Why I don’t prioritize greater rates of return.
Greater rates of return from growth stocks will be very powerful in building your portfolio value in the long run (assuming that greater return will continue). However, I personally prefer dividend growth investing even though they produce relatively slower growth. There are two points I would like to bring up.
Firstly, a greater return comes with greater risk (volatility). 12% annual return (the rate of return I was presented with as an example close to recent growth stocks or ETFs) is a pretty aggressive number and would come with a highly volatile journey. I think we have to acknowledge that we are not machines, but human beings with human emotions. A higher rate of return will end up in a higher portfolio value if you stick with it long enough, but will it be worth all of the stress of the high volatility? Many people couldn’t handle it and sold out at bottom prices due to fear and stress during the financial crisis (my father was one of them, so my thinking might be biased). This is something that is difficult to consider using numbers, but all too real to ignore.
Secondly, you don’t need high returns to achieve a financial goal. $10,000 invested at 7% rate of return (the average rate of return of the SP500) for 40 years will give you $163,000. If this exceeds ones personal goal, I don’t see much meaning in pursuing higher rates of return. It would just lead to wealth beyond ones needs with just more of the stress I brought up above. I think the purpose of a personal portfolio is to fulfill your specific needs and goals. Not necessarily getting the most out of your money as fast as possible. A 12% annual return will be $1,000,000 in the same time (which I imagine would be a very difficult rate to keep up for 40 years), but then why not go for 20%? Or buy tesla and go for 500%? The history books tell us how so many people ruined their lives chasing higher rates of return by buying growth stocks (many just ended up getting beaten by the market). You have to weigh the pros and cons of higher rates of return and draw the line somewhere.
I feel that building a dividend growth portfolio with boring but steady dividend stocks and focusing on increasing dividend income counter these problems nicely. For example the volatility of the dividend income from dividend kings like JNJ, KO, PG are staggering. They’re near zero and they have only been going up for the last 50 years. Meaning no volatility stress. In other words its a strategy very easy for a novice like me to follow. You just have to continue investing until you hit your goal.
It’s easy to compare end results, but I think the process is worth considering too. Especially if there were people who dropped out in the past, I think there is value in choosing a route that can prevent that.
However, I strongly agree that it is a slow strategy and simply investing 10-20% of your labor income will not get you far in the short run. That is why I started my own business so I can raise more capital. I am planning to invest around $1M in the next 5 years into my portfolio which will give me around $45,000 in annual dividend income. A very comfortable amount to live off of. Also, this amount will hopefully increase each year since I mainly invest in dividend growth companies.
3. Retiring off dividends and retiring off capital gains
Next, lets compare retiring off dividends and off capital gains following the 4% rule by the trinity study. Again, I personally prefer the dividend route.
The main conclusion of the trinity study was that if you withdraw 4% each year, your assets will probably last a lifetime. Since crashes happen roughly every 10 years, your annual income will decrease every 10 years. What if a sudden emergency expense happens at the same time? This will greatly decrease the lifespan of your assets and with it, the lifespan of your lifespan. According to Murphy’s law, “Anything that can go wrong will go wrong” and the probability of the two things I mentioned happening at the same time are simply too high for me. Of course the companies I invest in might decrease their dividends during such crashes too, but I feel more comfortable. In the past 50 years, every time the market crashed the capital appreciation of stocks fell which was about 9 times. So 9 out of 50. In the past 50 years, there were no instances where dividend kings failed to increase their dividends. So thats 0 out of 50. I think this low volatility is even more valuable in retirement.
Another thing I have to mention is that in the tougher scenarios in the trinity study, your assets will decrease over time. For me, this is extremely stressful just thinking about it. The decreasing value of your assets are quite literally your remaining lifespan. In such a situation “living a long life” becomes a risk. You would have to live worrying if your assets will last until you die. That sounds like a very dark retirement to me.
If you choose to live off of the dividends of stable companies, I feel it will be much less stressful. They are very unlikely to decrease more than the value of your assets and much more likely to increase over time. The longer you live, the more your annual income will grow. The best years (income-wise) will always be yet to come!
kyuto
