Monday, January 20, 2014

Why Dividend Growth Investing

As I have become more focused on my future, I have come to find that Dividend Growth Investing (DGI) makes perfect sense for me. There are countless other strategies out there and DGI may not be the best strategy for everyone but I do consider it a logical strategy that is potentially suitable for most long term investors. Here I will look at the reasons why I will primarily focus on the strategy for my own portfolio.

Additional Income

I have 2 main purposes for my portfolio. One is to throw off income that can be used to help support my family. I am getting married in May and will look to start a family within the next few years or so and having extra income coming in well be extremely helpful. Given my fiancĂ©e’s relatively low income, it is likely she would be a stay at home mom when the time comes. The idea of supporting a family of 3 (or gasp! 4) on my income alone is daunting. Hopefully we will not need this additional income and it can be re-invested but it is nice piece-of-mind to know that it is available if needed.

Investing in companies that regularly grow their dividends on an annual basis is a great way to get additional income from your portfolio. Obviously there are other income producing strategies but DGI specifically allows your income to grow each year so your purchasing power can keep up with (and often outpace) inflation. Many of the companies which have strong track records of dividend growth are companies that have strong pricing power. This allows them to increase prices and/or manage costs allowing them to increase dividends faster than inflation. Maintaining and increasing purchasing power is a strong benefit to DGI investing. While there is no guarantee that a DGI portfolio will outpace inflation, there is a reasonable good chance it will keep up with inflation as you are investing in strong companies with strong competitive advantages and pricing power. In addition, dividends have been more stable, historically, than market returns which makes this a fairly reliable income source. As can be seen in the current minimum wage debates, wages often do not keep up with inflation which can be damaging to a household’s financial well-being so I find this a particularly attractive component to Dividend Growth Investing.

Financial Independence

The second purpose of my portfolio is to help me reach financial independence. Like many, I long for the day when I no longer need to work to support me and my family. This has become especially important to me as the possibility of becoming a father becomes more real. Working 40+ hours a week (not counting time spent commuting to and from work) is a significant amount of time I will miss with my family. It could cause me to miss my child’s first steps or first words or a million other moments. When I reach financial independence it doesn’t mean I would necessarily retire but I would at least have the freedom to decide when and how much I work. It would also provide complete protection against a job loss since I would no longer need to rely on job income. This security would be invaluable.

Dividend Growth Investing is especially effective for this goal in my mind. Most people attempt to calculate a number to determine how much they need to become financially independent or to retire. There are various different ways to calculate it from a simple 25 times your annual spending to much more complicated formulas and calculators. Dividend Growth Investing attacks this problem from a bit of a different angle. Instead of focusing on accumulating assets to hit your number (which is difficult to correctly determine given all the variables around return, etc), it focuses on increasing the income produced by your portfolio. It is a lot easier for me to determine the amount of income I need to have to live my current lifestyle by tracking my spending. Historically, dividends have been much more stable than market returns and, as previously mentioned, dividend growth investing allows your portfolio and solid likelihood of maintaining or increasing your purchasing power. As such, once your portfolio begins to generate enough income to cover your spending, you have essentially become financially independent. To me, it is so much more logical to achieve financial independence by replacing my job income with a new reliable income source. It doesn’t matter to me if the market drops 40% when I am in “retirement” if my portfolio’s income continues to pay out ever-growing dividends. If I have only focused on obtaining a certain $ number, however, a 40% market drop would be devastating. While there will always be certain things that can ruin any strategy (unknown risks such as major medical problems, etc), generating income to become financial independent through Dividend Growth Investing is the strategy that makes the most sense for me. Now to generate that income so I can spend more time with my family!

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