Liam Gibson, Wealth of Geeks
As inflation rocked the economy last year, investors rediscovered the reassuring security of passive income. Dividend funds added a bumper $43 billion in the first half of last year.
The buy low, sell high trading strategy has become so ingrained in investing psychology that, until recently, many seemed to have forgotten the alternative: profiting through dividends.
The numbers show dividends are trending again, according to SPDR Americas. The shift makes sense — while dividends have made up 40% of stock market profits since 1930, during periods of high inflation, they’ve accounted for 54% of returns.
This column will dive deeper into this sea change and examine how newcomers can wet their toes with simple ways to build a dividend portfolio.
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The dividend returns
In recent decades, predictable dividends from established firms were overlooked in favor of huge capital gains from big bets on trendy growth stocks. Loose monetary policy created prime conditions for a flourish of highly leveraged tech unicorns that blew the market away with eye-popping IPOs.
Yet the era of easy money is ending, and the investing narrative is pivoting. Triggered by a historic burst of inflation last year, the Fed’s shift into aggressive monetary tightening has implications for every asset class, especially equities.
With low-interest rates gone, it’s becoming harder for growth stocks to continue selling the story of endless upward growth. Instead of relying on capital appreciation, investors want regularized returns, i.e., dividends.
“Extremely low interest rates allow investors and corporate management teams to waste money,” Daniel Perris, senior vice president at Federated Hermes, told Demetri Kofinas on the Hidden Forces podcast last year.
“And investors are willing to tolerate it because the asset prices are high and going higher, and the lower the interest rates go, the higher the asset prices can be.”
“There’s nothing wrong with that… but it’s atypical from a business perspective that you would get money for free… and be entirely dependent on a share price,” he said.
“I think the forces that we’ve seen have moved in a one-way trajectory over the past couple of decades have exhausted themselves. Over the next few decades, you’ll see some balance return where investors insist on a cash relationship.”
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Diving into dividends: Getting started
While the media is enamored with the cliff-hanging drama of the rise and fall of growth stocks, dividend companies quietly hum along and keep putting profits in investors’ pockets.
Undoubtedly less sexy than Silicon Valley startups, dividend investing typically flies under the radar. However, newcomers need to grasp some of the pillars of dividend investing to shift to an income mindset.
Consistency is the most critical factor in assessing a company for a dividend investing strategy. Companies that have withstood the test of time and have increased their dividends yearly for at least 25 years are eligible to become so-called Dividend Aristocrats. These well-established companies, such as Coke, Pepsi, and Walmart, have continued to bring value to their shareholders with a nice cash payout throughout the year.
Most companies pay out their dividend quarterly, allowing their investors to have that cash payout four times a year, but some may choose annually instead. The dividend yield payout is a ratio showing how much a company pays each year relative to the stock price. Investors need to look closely to calculate the predicated returns.
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Not all companies pay dividends
Generally, more mature, established companies tend to pay regular dividends, while newer, faster-growing startups reinvest their profits to expand their growth. There are apparent exceptions, though. Google, for instance, still does not pay its shareholders dividends, despite generating hundreds of billions in profit.
Google views its cash reserves as a means to invest in other projects to continue to grow the company. However, other tech companies like Microsoft and Apple pay out dividends and still have cash on hand to continue investing in their growth. No company’s strategy is quite the same.
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World’s wealthiest people like dividends
Some of the world’s wealthiest people have dived deep into dividend income investing. Bill Gates’ portfolio, for instance, has several companies that reliably pay out substantial dividends.
Gates, known as the creator of Microsoft and one of the wealthiest people in the world, has an impressive portfolio stacked with income-producing assets. The portfolio includes household names like Coca-Cola, Walmart, Caterpillar, FedEx, and Microsoft. All of these companies pay dividends to their shareholders.
From owning dividend stocks like Microsoft, Walmart, and other dividend aristocrats, Bill Gates brings him over $135 million yearly in dividends. Even in bad times during the economy, those valued companies continue to produce for Gates, which shows how valuable an income source dividend-paying stocks can be for your portfolio.
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Diving into dividends bottom line
It is important to note that dividend investing is not a get-rich-quick scheme — instead, it requires patience and consistency. However, the benefit of this approach is a steady stream of income, which can support one’s livelihood or be reinvested, allowing the investor to earn interest on their interest over time. In this way, dividends unlock the magic of compounding interest and can generate significant growth over the long term.
