Investing in Dividend Stocks Lets Me Sleep Soundly at Night
Lowering your blood pressure in an extremely volatile market
Investing in the current market can be stressful, to put it mildly.
I started building my investment portfolio with a simple ETF strategy like most people do these days. It’s easy to set up, relatively cheap, and if you understand the basics of how stocks and the market in general work, you won’t lose a lot of sleep over it. While it’s a sound way to invest (especially long-term), you can’t cherry-pick shares individually by the very nature of ETFs.
Slowly getting more comfortable with trading, I started researching companies I found interesting, building up a second portfolio of single positions. Some of these shares soon started to skyrocket because I picked niches that served the hype train (which can definitely be counted as a lucky coincidence).
The problem was and still is that I am not what you would call a day trader. If I go through the trouble of researching a company to invest in, I don’t do it in the hopes of making a quick buck. I buy into a company because I believe in the future of its business model and corporate governance. So the fact that you have to sell your shares to turn a profit always bothered me, no matter if I do it in a year or twenty years. With most shares at the moment, you will have to sell to reap those profits as actual money in your bank account.
A lot of assets have some incentive to simply buy and hold. For example, investing in real estate and renting it out gives you a recurring return on investment in the form of the rent minus expenses. Deposit bank accounts give you annual returns in the form of interest simply for letting the bank work with your money (it is worth noting that nowadays, you’d lose money doing that). Crowd investing incentivizes buying into new companies or real estate by paying out part of their annual profit to investors. Even modern cryptocurrencies use a technique called staking, where you can use your savings to help validate the network, earning rewards in the process.
So what about stocks?
Though the strategy seems to be less and less attractive for companies today, many stock shares have a similar incentive, called dividends.
What is a dividend?
Simply put, a dividend is a monetary return on investment for holding shares of a company in your deposit account. As described in Investopedia,
A dividend is the distribution of some of a company’s earnings to a class of its shareholders, as determined by its board of directors. Common shareholders of dividend-paying companies are typically eligible as long as they own the stock before the ex-dividend date. Dividends may be paid out as cash or in the form of additional stock.
What’s so great about it?
It disciplines a companies management decisions
Companies that pay dividends are less likely to take unnecessary risks and carefully plan to keep increasing or at the very least upholding the dividend. Paying out part of a company’s profits to its shareholders adds a constraint to the management’s investment decisions. All spending decisions must be vetted carefully to avoid cutting the dividend in favor of rampant acquisitions or excessive executive compensation. A constant payout of part of the profit makes it harder to commit fraud or make the earnings look better than they are (partly because the dividend has to be raised to please the shareholders). Wirecard probably wouldn’t have been able to artificially inflate its earnings by the billions if it would’ve meant that they would have to adjust their dividend payouts accordingly.
Most dividend-paying companies can be considered “boring” because they tend to have a more conservative business model and don’t have an insane return on investment. The growth is usually slow and steady, with new investments or acquisitions being weighed carefully against damaging the shareholder value. That is exactly what I am looking for in fresh recruits to my dividend portfolio.
Many high-growth companies like Uber or Airbnb rely almost entirely on mountains of debt to keep their business model afloat. While it can be considered a good trade in a company to keep expanding, it also leaves the door open for sudden bankruptcy if a crash (and/or pandemic) hits the market and the creditors come knocking.
Knowing companies distributing a dividend have the added gatekeeper of keeping an eye on the cash flow lets me sleep soundly at night.
A constant cash flow
It’s nice to have a constant flow of dividend payouts over the year. The dividends are subtracted from the share prices at the ex-date, which means that it’s not “free” money on top of an increasing share price (contrary to a weirdly widespread belief). The simple fact that I don’t have to sell to reap any rewards appeals to me, though, getting a part of a companies profit each year without having to do a thing. While I reinvest all dividends at the moment, I plan to use the added income stream for at least part of my living expenses when traveling or retiring in the future (or if I decide to do a mini-retirement in between).
During the corona-induced flash crash in 2020, I also realized that most of the companies kept distributing their dividends even though the share price was cut in half at the time. Some companies slashed part of the dividends, but I would consider that a good thing because the management played it safe instead of siphoning money off of a decreasing profit. Most of the dividend-paying companies had a solid long-term strategy for the cash flow and sufficient savings at hand to bridge the losses during the crash. In the end, even a market crash didn’t affect the dividend payments as much as I initially thought it would. I didn’t get a full-on heart attack seeing my portfolio losing almost half its value (well, maybe a mild one).
You buy into the stock market to make some money short or long-term, but at least hedge against skyrocketing inflation rates. I find companies upholding increasing dividend payouts combined with steady growth a good instrument to do just that without having major headaches.
Peace of mind
Cryptocurrencies seem to generate money out of thin air, with a simple tweet being able to send the whole crypto market crashing, obliterating billions of dollars in hours.
Trading newcomers finally understand the power of social media when it comes to investing, using it to utterly humiliate large hedge funds and even confusing modern Artificial Intelligence. While the stock market has always been run by emotions, this way of crowd investing brings in a whole new level of volatility.
Investing in high-growth assets will eventually turn into a bigger profit if you do it right (or you’re lucky), but investing at least part of my money into “boring” stocks is saving me from constantly having to check the market and losing even the last bit of hair I posses.
As stated earlier, I also found it weird having to sell my stake in a company to turn a profit. Investors usually want to have a constant part of the pie when they invest in a company; why should it be any different when you buy shares? While you usually have a higher yield on so-called growth stocks, it also means you’ll have to try to time the market just right when selling and you’re pretty screwed if you want (or need) to turn a profit amid a crash or bear market. Investing in dividend shares enables me to have more of a long-term view on my investments, so a crash not only isn’t the end of the world but enables me to buy more stocks on a bargain.
I don’t try to beat the market or fear an impending crash, which takes a lot of emotions out of my monthly retirement investments. Of course, you can follow the same strategy with any stock to invest long term, but you still have to sell them in the end to realize a profit.
Less work
It’s safe to say that buying into dividend shares does not by any means absolve you from doing your homework after the fact. You wouldn’t buy a house without continuous maintenance work to keep up its value (or would you?).
After the initial research before buying a stock, I usually don’t follow the price fluctuations anymore; all I do is check the income statements bi-annually. Any news concerning the company to verify if the stock still matches my investment criteria.
Picking specific shares is still more time-consuming than simply buying shares of an ETF, but (at the moment) I like to pick the companies I buy into myself. Diversifying is harder, but then again, you don’t need huge positions for every company in your portfolio because buying shares through neo brokers is cheaper than ever, or even completely free of charge (on the surface). So buying individual shares on a smaller scale doesn’t eat up your fee to buy-in ratio anymore.
Similar to the general stock price, dividend payouts usually increase every year by 5–10% or more (depending on the annual profit) with the right companies. That means your yearly passive income of dividend payouts will increase automatically. Simply reinvesting the dividends will increase your cash flow exponentially over the long term.
Consistent shares of the profit build trust
The reasons for a company to pay dividends are manifold, but it usually comes down to building trust. Rewarding buy-and-hold shareholders with a constant piece of the cake makes them less prone to sell. Annually increasing dividends imply the management’s trust in the financial health of their company (though it pays to check the company’s fundamentals from time to time). So a solid dividend payout history can usually be seen as an indicator of a companies well-being. If companies can increase the dividend payouts over years on end, it shows that the management is making well-considered long-term decisions.
It’s important to note that I diversify my portfolio quite a lot, with dividend shares making up only a portion of it. I’m still (relatively) young, so my threshold for taking risks is pretty high, which means I also have many high-yield (and therefore high-risk) assets in my portfolio. I’m not trying to pitch dividend stocks against high-growth assets but simply felt like highlighting the advantages of having at least part of my money invested in companies that consistently pay out part of their profits.
It was also quite fun to do some additional research on the topic.
So to recap, here are my reasons to invest in dividend-paying companies:
- Consistent payouts demand better long-term planning from the company‘s management
- You get an automated passive income stream just holding the shares
- You don’t have to check the market constantly
- A solid dividend history usually reflects a companies’ well-being
Disclaimer: I am still considering myself a rookie when it comes to investing in the stock market and do not presume to know all the facts. All thoughts stated in this article reflect my personal opinion and should not be taken as financial advice. Always do your own research and find out what works best for you.
