Dividend Growth is Psychological

Throughout the years I have tried to quantitatively justify my attraction to dividend growth investing to both myself and others.  However, I never felt 100% satisfied with my explanations.  It is not that I did not believe the math & analysis or the books, articles and studies I have read on the subject. I just knew there was something else and my conclusion at the end of the day is that psychologically it comforts me.

Through self-reflection I have come to the conclusion the reasoning why it is psychologically comforting is simply a reflection of the environment I was raised in.  Since my earliest memories of childhood, I have been told that to be an adult you need to earn a regular paycheck and pay bills.  This is what I was taught by both my parents and educators.  This is how children’s books, cartoons, media, and movies depicted adults.  When I looked around at other adults (Aunts, Uncles, friends, etc..) this is what everyone else was doing, this was and still is the social norm.  Essentially, I have been psychologically programmed to expect a regular paycheck and to pay my bills every month.

This psychological programming explains why I was struggling to envision how to drawdown my wealth when I hit financial independence or retirement.  For me, saving a pile of cash was intended for buying something or to have in emergencies.  But to use a pile of cash to drawdown from to pay for day-to-day expenses was just difficult to get my head around.  My only choices were to either break my programming or find a different alternative.  I obviously choose the easier of the two paths and went to the alternative by using dividend growth investing which focuses on investing for cash flow. 

A growing cash flow felt like such a natural replacement for a paycheck.  I would get regular disbursements and the dividend growth aspect was like getting an annual raise at work.  Mentally this was a replacement for what I have been doing for the last 35+ years.  I completely understand that if I embrace a total return investing style (equity growth + dividends) my wealth might be greater however I also want to be mentally comfortable in so much that I have the luxury of focusing on other things in life and not money.   This is the number one reason why I chose and will keep continuing down the dividend growth investing path.  From my perspective I would rather spend my energy on other things in life rather than undoing my programming. Yes there are risks with this investing style but there are risks with any investments and that is okay if you recognize what they are and plan for them accordingly.

Today we are in a bear market with the S&P down 20% and the NASDAQ down 28%.  For young investors that have never experienced a bear market it seems like the worst of times.  For older investors it feels like retirement just moved that much further out.  For retirees that did not have a significant cash position now face a risk of cashing out more shares than they planned.  But as a dividend growth investor my dividend income is not down 20 or 28%.  As a point of fact, my June dividend payments this year will be larger than last June and next year’s payment will be larger than this year.  This is a comforting feeling and leads me to a feeling of being simply content.  Being content I can relax and enjoy the simple things in life while not stressing over finances.  What is your motivation for choosing dividend growth investing?

Buys and Sells for the Week 6/24

Normally post this at the end of the day but all my trades were done early in the week and my brokerage account only has a balance of 9 cents. Here are my trades for the week:

1. Packaging Corp of America (PKG)   – increased position – Have we hit a bottom yet? Grabbed 1 share @ $134.14 and a 3.73% yield.
2. Schwab US Dividend Equity ETF (SCHD)   – increased position – Still priced near its 52 week low. Grabbed 3 shares @ $70.53 and a 3.21% yield.

Buys and Sells for the Week 6/17

Another crazy week of down markets and we even saw the Dow dip below 30K after Thursday’s close. Not sure how much lower things will go but I’m in a buying mood. Also here are a few symbols I like but didn’t buy because I ran out of cash; AOS, ADP, BLK, HD, SNA, TXN, and WSO. Here are my trades for the week:

1. Packaging Corp of America (PKG)   – increased position – Trying to increase one of my smallest portfolio positions. Grabbed 1 share @ $145.51 and a 3.44% yield.
2. Schwab US Dividend Equity ETF (SCHD)   – increased position – Went from a little in to all in. Grabbed 39 shares @ $70.59 and a 3.21% yield.
3. Hasbro Inc. (HAS) – increased position – Is the recession going to hurt toy sales? Don’t know but like the price below $80. Grabbed 1 share @ $79.47 and a 3.54% yield
4. Medical Properties Trust (MPW)   – increased position – Too cheap to ignore and cannot imagine hospitals not paying their rent. Grabbed 3 shares @ $14.37 and a 8.07% yield
5. Garmin Ltd (GRMN)   – increased position – Its been 5 years since I added to this position. Grabbed 1 share @ $93.77 and a 3.11% yield
6. Algonquin Power & Utilities (AQN)   – increased position – At this price the yield is hard to ignore. Grabbed 7 shares @ $13.06 and a 5.51% yield
7. Bar Harbor Bankshares (BHB)   – increased position – Used the last of my cash on this buy. Grabbed 1 share @ $24.71 and a 4.21% yield
8. Allete Inc. (ALE)   – increased position – I do like utility stocks as electrical grids keep expanding to accommodate EVs. Grabbed 35 shares @ $56.80 and a 4.58% yield

Buys and Sells for the Week 6/10

Received just one dividend raise so far for the month from Oil-Dri Corp of America (ODC) for a 3.7% raise. Didn’t make any trades last week but back on track. Here are my trades for the week:

1. Packaging Corp of America (PKG)   – increased position – Trying to increase one of my smallest portfolio positions. Grabbed 1 shares @ $157.98 and a 3.16% yield.
2. Best Buy (BBY)   – increased position – Retail stocks will stay on the ropes may as well take advantage. Grabbed 2 shares @ $76.33 and a 4.61% yield.
3. Medical Properties Trust (MPW)   – increased position – Share price has been steadily dropping. Grabbed 4 shares @ $16.81 and a 6.9% yield.
4. Schwab US Dividend Equity ETF (SCHD)   – new position – A new addition for my ROTH IRA. Grabbed 7 shares @ $76.52 and a 2.96% yield.

Living off a 100% Dividend Growth Portfolio May Have Risk

The idea of living off dividends and not touching the principal is always an appealing thought and I judge no one negatively for striving towards this goal as long as they enter the journey eyes wide open.

The two counterarguments to income investing I hear regularly are 1. What happens when dividends are cut? and 2. What about inflation?   In response to these two questions is the Dividend Growth Strategy and then the debates go on from there.  I am a big supporter of Dividend Growth but also grounded in the reality that it is not risk free. 

The two counterarguments have some merit albeit not as much of a “gotcha” moment as critics think.    As for dividend growth investors, the day you decide to retire and live off a portfolio with a 100% allocation to dividend growth stocks you may have just exposed yourself to a Sequence of Returns risk.

The best example to demonstrate this would be the 2008 great recession as the collapse of the financial industry had the largest effect on dividend cuts in the markets.  The Vanguard High Dividend Yield Index Fund (VYM) will be used to represent a basket of dividend growth stocks that generates $20,000 annually in dividends for someone that decides to retire on January 1, 2008.

From its dividend high of 2008 to its lowest point in 2010 our retiree would have seen their annual income from VYM drop from $20,000/yr to $15,120/yr.  If the retiree can figure out how to cut expenses and live on the reduced amount their reward for their sacrifice would be a return to the $20,000/yr mark in just 3 years.  However, if the retiree cannot cut expenses, we now run into a sequence of returns event.

The only way to meet their expenses a retiree begins to sell-off equity to cover the gap in dividend income.  However, selling stock reduces the amount of equity that can benefit from the dividend increases from 2011 to 2013.  Our retiree ends up selling off circa $11K of their portfolio and loses $460/yr in dividend income.  It now takes just over 4 years for the annual dividend income to recover.

	Total Equities Sold	Lost Dividend Income	Years to recover
No to Low Inflation	$10,758	$430.34	4

Luckily for the retiree inflation was non-existent to low during this time which allowed for a decent recovery.  But what would have happened if the first 3 years of the recovery period there was 8% annual inflation and then 2% annual inflation every year after that? With an 8% inflation rate our retiree would have ended up selling circa $19K of their portfolio and loses $756/yr in dividend income.  It now takes our retiree 7 years for the annual dividend income to recover.

	Total Equities Sold	Lost Dividend Income	Years to recover
No to Low Inflation	$10,758	$430.34	4
8% Inflation (first 3 years)	$18,893	$755.70	7

While the dividend income may have recovered in the short-term, it may cause a shortfall long-term.  That $756/yr in dividend income loss will never participate in future dividend growth and can throw a monkey wrench in where you thought your income might be 20 years down the road. Without that $756/yr earning dividend growth you potentially decrease your annual dividend by $3,500/yr 20 years down the line.

The easiest way to mitigate this risk is the same as in any other portfolio and that is with cash.  If the retiree included a cash position as part of the portfolio equal to 1 year of dividend income the cash could have been used to fill the gap until dividend recovered allowing all your original equity to benefit from a rising market.

	Total Equities Sold	Lost Dividend Income	Years to recover
No to Low Inflation	$10,758	$430.34	4
8% Inflation (first 3 years)	$18,893	$755.70	7
Portfolio w/1yr of Cash	$0	$0	3

The other option that could have mitigated this scenario is if dividend income greatly exceeded your expenses (by at least 30%) at the time of retirement.  While some may achieve this mark, the bulk of investors probably will not and should not plan to have a portfolio 100% dedicated dividend growth stocks but include some allocation to cash.

While an almost 25% dividend cut is difficult to live with, when you put it in perspective to the S&P 500 which during that time it dropped 56% and took 5 years to recover in a no to low inflation environment.  The amount of cash you need allocated to offset that would have greatly exceeded what a dividend growth investor needed to avoid a sequence of returns risk (imagine a cash position anywhere from 2 to 4 years of annual expenses).