Eric, the blogger behind The Passive Income Earner, has a fascinating look at how he makes money. On his blog, he breaks down where his money goes, why it's going there...and most importantly, his results. He spoke with us about passive income, dividend investing and other topics. Read on:
What is dividend investing, and how does it work?
Dividend investing is an investment strategy focused on filtering stocks that pay a dividend. If a stock doesn't pay a dividend, such as Google, you filter them out. That's really the basic principle. Next, you can look into blue chip dividend companies, which means they need to be established companies that are profitable and provides products and services well known. Usually, such blue chip companies will have a large market capitalization, which helps a dividend investor filter out smaller and less established dividend companies. A more rigorous list of companies come from the dividend aristocrats, which only list the companies that have paid and grown their dividends annually for 25 years. Those companies are perfect to set up a compound growth portfolio where you reinvest all of the dividends to produce more dividends.
Ultimately, my goal is to be able to retire from dividend and leave my investment principal intact. That way, I don't have to worry about depleting my portfolio, and with dividend increases, I should be able to keep up with inflation. It does go against the theory of having a lot of bonds in retirement. I have very little bonds so far, and I am well diversified across sectors and between Canada and the US.
Is dividend investing for everyone? Why or why not?
It is not for everyone. You do need to research the companies and pay attention to them over time. More so if you don't buy blue chip companies. It's not a lot of work but those not wanting to look at anything related to company finances are better to just go with index investing.
I would say that if an investor wants to go with the dividend investing approach, they will spend a few years refining their strategy based on their risk profile and account setup for tax efficiency. After a few years, you really can find out what you like or do not like. For example, do you want to DRIP the dividends or not? What payout ratio works for you or what dividend yield is appropriate versus dividend growth?
How much income can you earn from dividends? What's a realistic way to treat it?
My back of napkin is to estimate 4% in dividend income from the investments as a Canadian, considering how much the banks, the telecom and the energy sector pays. A more conservative approach would be 3%. The income mentioned is based on the portfolio value and not the invested amounts, as many companies can increase their dividends. If you are focused on fixed income like REITs, your income can be higher, but the growth is limited.
As a rule, the income you can generate is dependent on how much money you have invested. What is good is that you should reinvest the dividends early on to accelerate the growth along with the appreciation of your investments.
If you get a dividend, should you keep the money or put it right back into stocks?
It depends on where you are in your investment life. Early in life, you should reinvest it. I am of the opinion that I let my dividends DRIP in the same companies every time I get a dividend. Others prefer to pool the cash and buy selectively, but it can take a lot of time to accumulate enough to initiate a position in a new stock.
Later in life, when you near retirement, it becomes prudent to keep more cash around and let the dividends sit in cash.
So far, whenever I have enough to purchase a share, I let the discount broker purchase that share. Most of the companies even have a discount on DRIP shares.
How does dividend investing fit in a larger investing strategy?
It's all about income but also about safety. Companies that pay dividends have to manage their earnings and payout so that they have enough cash for the dividends but also to reinvest in the company where needed. When investing in blue chip companies, you forgo investing in small companies that have high growth potential with high risks. Basically, your upside can be limited as well as your downside. Obviously, this is the stock market and there is always an inherent risk, but when companies have been around for over 100 years and have paid dividends for nearly that long, you have to assume there have been good management teams along the way.
What are some trends in investing we should keep an eye on?
I do think that index investing is a valuable strategy for any investor. I use that strategy for the plan offered through my company as it is all invested through mutual funds. It's simple and effective, but in retirement, you have to approach income differently.
For more from Eric on dividend investing, keep up with his latest insights on Twitter.