This post is in response to a comment I received, saying that “dividends don’t matter, because your total return (capital appreciation + dividends) would be the same, if the company did not pay a dividend but instead re-invested the cash”. In theory, I must say, that is indeed true. But the key assumption here would be that the company is able to re-invest the excess cash at the same rate of return. However, I still prefer to invest for dividends, and in this post I will outline my reasons for my preference of dividend investing. I have been investing for dividends since 2015 and will continue to do so.
As many of my long-time readers would know, I am pursuing FIRE, which is to become financially independent and retire early. Thus, for someone in my mid-20s, in some ways, I tend to think like a retiree. My reasons for choosing dividend investing is written with this in mind.
In a traditional retirement portfolio, the aim would be to sell a portion of your stocks/bonds each year to fund your expenses. But what happens in a year when both stocks and bonds get decimated, like in 2022? By the way, 2022 is the worst year in a 100 years for the 60/40 (60% in stocks, and 40% in bonds) portfolio, as per Bank of America’s research.
Assuming the market tanks by 50%, a retiree who depended on selling assets to generate cashflows would have to sell twice the number of stocks/bonds to get the same amount of cash. Let’s say a retiree has just retired with $1 million in 2022, allocating 60% to stocks and 40% to bonds. Following the traditional 4% drawdown rule, the retiree would want to receive $40k a year in cashflows, generated from selling a portion of their portfolio each year. In a year like 2022, the retiree would have to sell a greater number of stocks/bonds to generate the same $40k, which would deplete their portfolio permanently.
In contrast, someone with a dividend portfolio paying out 3-4% would be less affected. While dividends may be reduced during recessions, capital remains intact and there would be no need to sell during market lows. If one simply buys dividend paying ETFs, the stream of dividends are relatively predictable.
Many people began investing during the last few years, in a period of unprecedented outperformance of Growth vs Value. Understandably, most would gravitate towards Growth stocks to chase higher returns. But let me highlight that in March 2000, during the dotcom bubble, the Nasdaq peaked above 5,000 before the crash, and it took more than 13 years before it surpassed that peak in late 2014. 13 years of being underwater. Imagine if one had bought at the peak, one would have taken more than 13 years to recoup their capital. In contrast, a dividend investor would continue to receive dividends during those 13 years, somewhat softening the pain of capital losses. Now, if we believe that Growth stocks peaked in 2021 and that higher rates will continue to hammer Growth, we could very well have to wait another decade to before we see the Nasdaq at 15k again. Dividend cushion your portfolio and returns in volatile times like this.
Another reason for going for dividend paying companies would be if you believe you can re-invest the dividends at a higher rate than the company. Some companies are asset heavy with low ROEs, but are stable dividend payers (REITs, utilities and infrastructure). In this case, it would make sense for an investor to receive the dividends, and re-invest them to seek higher returns.
Lastly, dividends tend to increase over time. Look at the dividend history of an index like the S&P500 or even our local STI. As companies grow, they also grow their dividends. This is why I prefer dividend paying companies over fixed income instruments, where the coupons are generally fixed.
A hypothetical Dividend Portfolio
Assuming I had $1.5 million SGD today, how would I create a dividend portfolio?
My aim would be to generate $50k SGD in cashflows annually (a 3.33% yield, very conservative in today’s market), which is around the median income of Singaporeans. The instruments I would consider adding into my dividend portfolio would be, in no particular order:
SCHD – Schwab US Dividend Equity ETF, 2.47% yield, net of withholding tax
VEA – Vanguard FTSE Developed Markets ETF, 2.8% yield, net of withholding tax
2800HK – Tracker Fund of Hong Kong, 3.68% yield
STI ETF – Straits Times Index, 3.72% yield
S-Reit ETF – Any one of the S-Reit ETFs, ~6% yield
Singapore Savings Bond / T-Bill – 3.21% yield for Oct 2022
I believe allocating my cash into all 6 instrument above would give me good exposure to a wide range of stocks across regions and sectors, which are well diversified. Even in a recession when dividends are expected to be cut, I believe having a diversified portfolio would mitigate the overall impact.
Thus, in my view, if one is able to generate $40k to $50k annually with reasonable certainty, then whether the underlying portfolio rises to $2 million, or falls to $1 million, one should be indifferent. What matters is the consistency of cash flows, regardless of the market cycle.
As to how to reach that $1 million, $1.5 million or even $2 million… that’s what my journey is about. Follow me on my journey to financial independence – I post monthly portfolio updates on @alpacainvestments on Instagram.
