My main college job during the summers was at an ice cream shop. My boss was very generous to the employees and allowed us to have an ice cream for free while on the clock. Unless it was too busy, I would typically enjoy a nice soft serve coffee ice cream cone with chocolate jimmies during my shift. So while I was still earning money while customers came to the window, I got a little extra bonus in the form of the free ice cream. That’s pretty much how dividend investing works. You invest in the stock and the company pays out a certain amount per share to each shareholder. The average amount that a stock in the S&P500 pays out in dividends is 2%, so it really rewards larger shareholders.
What's the Benefits of Dividend Investing
Companies that focus on paying dividends are trying to keep stockholders happy. It is valuable to companies to have people hold onto their stock for a long period of time. In fact, paying out consistent dividends, even when the stock drops in value can be a good bulwark against a mass sell off. After all, if the company is still paying out dividends in the bad times, they’ll certainly continue to reward the stock holders in the good times. For the investor, there are two main benefits to buying and holding onto high dividend paying stocks:
- The dividend can be used as a form of passive income or can be reinvested into the same company’s stock
- Typical high dividend stock companies are large, stable corporations
Being able to reinvest dividends is good for both the investor and the company. For the investor, they get to increase the number of shares that they own. Most companies allow them to buy fractional shares when they’re purchased with dividends. For the company, the dividend that they just paid out is getting reinvested, meaning that they’re not actually losing that cash.
The Ultimate Buy and Hold Dividend Strategy
In the financial independence community, there are many paths to financial independence. Focusing on dividend and growth is one of the investing strategies that can get you across that finish line. The main idea behind this is that you can live solely off the dividends that your stock portfolio pays out. This isn’t a get rich quick scenario. It will take a long time with a lot of growth in order to get your portfolio to the point where you can live off the dividends. Using the 2% dividend payout that I used in the intro, it would take a portfolio of ~$2.2 million to have $100,000 of dividends. And with everything stock market related, there are no guarantees, just good estimates.
Aren't You an Index Fund Guy?
Great question. Yes, I am. And with most other things in my portfolio, I look to see what Vanguard has to offer. And wouldn’t you know it, they offer a Dividend Growth index fund. I’ve linked it there so that you can check it out if you’re more interested. If you look at what the fund holds, the top ten holdings include American stalwarts such as Johnson & Johnson, McDonald’s, UnitedHealth Group, and American Express, and Microsoft. This is a pretty big deviation from Vanguard’s Total Stock Market index fund, which heavily leans towards the technology field. The top holdings of that fund are Apple, Microsoft, Amazon, and Alphabet (Google). So if you feel that the tech field is overvalued (Tesla is 6th largest company in the total stock market fund), or just want to diversify your portfolio a little more, this is one good way to do it.
What's Changing for My Portfolio
One of the main reasons that I write about investing is to give myself a reason to do a deep dive into a different investing topic. I think that index fund investing what’s best for a common investor (myself included). The benefits of passive income and extra diversity in my portfolio is definitely enticing. The dividend growth fund focuses on companies that pay a decent dividend now, but more importantly projects to increases their dividend payouts in the future. The dividend growth fund often underperforms the total stock market index in gross capital gains, but the extra dividend payout provides both passive income and can help make up the difference. I’m planning on incorporating the growth dividend fund as a small part of my portfolio, maybe 10-15%. That way I’ll have better exposure to companies different from the primary ones in the total stock market index.
Disclaimer: I am not an investing professional, just a guy trying to learn the best ways to work towards financial independence. None of this is a guarantee of future returns and you should use your own discretion and know your own risk tolerance when investing in the stock market.