Saturday, December 1, 2007

the human side of dividends

I often think that dividends and dividend growth are concepts in equity investing that are overlooked by the masses. Most people who have only a casual knowledge of investing think that growing the value of your investment means watching the value of your stocks increase. While this is partially true, dividends are like a fabulous goaltender playing on a team that is known for its powerhouse offense. Perhaps not as exciting and directly effective as a strong forward line, but certainly equally key to winning in the long term.

So what is so special about dividends and dividend growth in your portfolio? Aside from what dividends might tell you about a company, and why they'll boost your returns, what benefits do dividends and dividend growth have for you, in your day to day struggle?

The 3 P's
  • Psychological. Psychologically, dividends are a great friend. When the markets are haywire and your stocks are down day after agonizing day, your dividends will still arrive on time. Not to despair, your dividend payment will likely be raised in due time. Dividends are like a hot tea on a cold winter's night, comforting you always and allowing you to stick to your game plan knowing that they will always rein your stocks back in over the long term.
  • Permanence. Dividends supply permanence to your analytical portfolio tracking. What I mean by this is that when I feed a new value that represents a recent dividend increase into my portfolio spreadsheet, instantly I am being paid more money per year than I was yesterday, and I really like that. Whether a company increased its dividend, or a dividend was paid in one of my DRIPs, it activates a permanent positive change to my financial well being forever. Simply stated, the market could rise 5% in a single day and I would not be as happy as I am when a company I own comes in with a strong dividend increase. The dividend increase is extremely likely to be a permanent change, whereas the fickle market could tank 10% the next day.
  • Payment. I like paper gains in stock prices as much as the next guy, but sometimes times get tough and you aren't saving as much money to invest anymore. Your employment income might take a temporary hit, or an unexpected expense crops up taking away from your capital available to invest. It's times like this when dividends are 'money in the bank'. Close your eyes to your portfolio for a little while; heck go on vacation. I'll bet when you get interested again your dividends will have magically piled up some money in your pocket to do as you please, whether that is to invest it or book another week in the Mayan. I'd prefer the latter during weather like this....


pitz said...

Dividends are also attractive if you funded your portfolio with debt, and need to remove some value from the portfolio. You can withdraw the dividends from the account and spend them, but if you start selling shares, you are obliged to first repay the loans, or else they lose their deductability.

But one danger of dividends is that firms can overconcentrate on paying them instead of cutting them when conditions are prudent. For instance, all of the big US banks that have credit problems at the moment should be cutting their dividends to shore up their balance sheets, but most have yet to do so. Also, income trusts pay dividends that are often so high that they cause significant damage to the balance sheets. So while dividends are good, blindly seeking them can be very dangerous to one's overall financial health.

Gammafriend said...

Good article again. I pass your comments on to my kids (grown) who don't have the time or the inclination to read a book on investing, but will sit down and discuss your investing "bytes".

Thicken My Wallet said...

Dividends are also very tax friendly (depending on the province you live in, up to $40K in dividends is tax free)!

ktradr said...

which province is that?

dan said...

Ontario it's around 38k or so