Dividend stock investing is one of my favorite forms of “Levered Income.” There are several different approaches to dividend stock investing. Still, the primary dividend stock investment strategy is to create enough dividend stock income that you do not need to deplete your capital in retirement.
In a sentence, the best dividend stock investment strategy is to aim to build a dividend portfolio to pay you more yearly (after taxes) than you spend. This article is not about tactics (i.e. what to look for when buying a specific dividend stock), it is about the overall dividend stock investment strategy.
Before we get into dividend stock investment strategy and how it can add to your residual income, let me just say a couple of things:
An investment is something that pays you (income).
A speculation is something that you buy and hope that someone in the future will pay you more for.
Think about it, how can you leverage the work output from some of the world’s best companies and get monthly or quarterly income?
Invest in dividend-paying stocks.
A Solid Dividend Stock Investment Strategy is One of the Most Powerful Income Levers You Can Pull.
Dividend Stock Investing is one of the most powerful levers you can pull. You are leveraging professional management, the company’s reputation, the company’s credit, the company’s supply and distribution chains, patents and intellectual property, the company’s earnings, and the company’s workforce. All of this leverage comes from just buying the company stock.
Own the World’s Best Companies for the Price of One Share of Stock
With a touch of a button, you can buy some of the world’s best companies for no transaction fee and just the price of one share of stock. In addition to access, most brokerages offer free-of-charge earnings reports, 24/7 company news, and analyst predictions. The company ownership benefit is distributed regularly in the form of dividend payments.
Some of these payments (like qualified dividends) even get specialized tax treatment.
Growing an Income Stream versus “Fixed Income” Streams
Suppose you invest in dividend stocks with a history of growing their dividend payments over time (a dividend stock investment strategy more popularly known as “dividend growth investing”). In that case, you are actually growing your income stream over time. Your dividend “business” is now paying you a consistent income stream, and you are growing it slowly over time.
Other dividend investments have a “fixed” income stream, such as preferred stocks. Those types of investments pay the same amount throughout the life of the investment. If you get $10 per month from the investment and hold it for 30 years, you will still only be getting $10 per month 30 years from now. Unfortunately, the $10 per month payment is worth considerably less with inflation. Focusing on interest rate swings and strategically adding can bump your current income.
Quoting Warren Buffett
Everybody loves to quote Warren Buffett.
He spells things out simply and clearly.
I think the quest for simplicity is a big reason for his success. Simplicity in life is something I crave because it helps me keep a clear head and reduces my stress level. If I can leverage a bit of technology to simplify my life, I will do it every time.
I especially love Warren’s Simple Rules to Investing:
- Rule Number 1 – Don’t Lose Money.
- Rule Number 2 – See Rule Number 1
The first time I saw this, I laughed out loud. So simple, so elegant, and so true. I started to think back and remembered when growing up; my mom taught me the three golden rules of real estate:
- First Golden Rule of Real Estate – Location
- Second Golden Rule of Real Estate – Location
- Third Golden Rule of Real Estate – Location
I thought it was a joke back then.
What about the building on the land? Wasn’t that important also? Time and time again, I saw that renovating the worst house on a great street yielded the best results. She was right. That little tidbit of advice proved invaluable over my real estate career.
Although they aren’t making any more real estate (well, they are building islands in Singapore), location has proven to be the deciding factor in the majority of capital gains appreciation and rental increases I have experienced. Properties in lower-quality areas did not appreciate as quickly and required more handholding to stay profitable.
Location. Location. Location.
My Rules of Investing
I started to think about what my three rules of investing in anything would be:
Here are my three rules for investing:
- Rule Number 1 – An investment pays you money.
- Rule Number 2 – An investment pays you money.
- Rule Number 3 – An investment pays you money.
Looking at the above, I realize that there is always an overall rule that is so important; the simplicity of repeating and remembering the rule outweighs adding another rule and increasing the complexity. One day I realized that I was speculating versus investing. I was buying a stock (or mutual fund), always hoping it would go up versus focusing on the income the stock was generating.
The Definition of Insanity
Looking back now, it seems insane that I was waiting for a stock to go up so I could sell it to someone else. But I was ‘investing” in my future, so I was buying and HOLDING! Not even selling to someone else if it went up. I rode stocks up and down for years.
If you buy a stock for $10 a share and it goes up to $100 per share and then back down to $10 a share over a 10 year period, what have you really made?
Look at a stock chart; stocks always go up and down.
Let’s look at Tesla (TSLA) as an example:
Suppose you need the money when the stock is up, great!
If you need the money when the stock is down, ouch!
I remember one year, my mutual fund value went down and I still owed capital gains taxes for the buying and selling the mutual fund did over the year. I let them invest my money for a year, received no interest, no capital gains, paid the mutual fund’s management fees (they always get paid), and paid extra taxes – way to go!
The definition of insanity is doing the same thing over and over and expecting a different result.
Years ago, I changed how I approached investing and focused on how much money an investment paid me while holding it.
My Three Types of Dividend Stock Investment Strategies
I like simplicity, so I only have three different strategies for dividend stock investing. They are:
1. Dividend Growth Dividend Stock Investment Strategy
I spoke about this above, but in a nutshell, this is investing in high-quality companies with a consistent history of paying and increasing their dividend payments. This can include both dividend stocks and real estate investment trusts.
2. Fixed Income Dividend Stock Investment Strategy
This is investing in securities of high-quality companies with fixed payments, such as preferred stocks or other interest-paying investments. Typically less risk, but you are giving up any possibility of dividend growth.
3. A Blend of 1 and 2 for a Diversified Dividend Stock Investment Strategy
Blending the two approaches can reduce risk as well as increase current income. I use this approach to smooth out the income stream for my dividend income business. In periods of high-interest rates, I try to add more fixed-income instruments to lock in these payments when interest rates dip in the future.
Still Not Passive Income
Nope. Income from dividend stock investing is not passive income.
You must research and understand your dividend investments and plan your dividend stock investment strategy. Knowledge is power. Investing in quality companies and MONITORING their progress is critical for your dividend income business. Fortunately, there are a lot of free tools in the financial industry to help with this.
Some things to watch out for:
- Is the dividend a “sucker yield” (a temporarily elevated yield due to a stock drop immediately before a dividend cut)?
- Is the dividend covered (can the company afford to payout the dividend without borrowing the money)?
- What is the dividend payout ratio? (Higher is worse).
- Is the company or fund selling off assets to pay the dividend?
So What is the Best Dividend Stock Investment Strategy?
The best dividend stock investment strategy – as with all investment strategies – depends on your individual needs at the time.
It is also important to remember that the strategy WILL change. You need to be flexible and understand that this lever might need to be pulled more softly (reinvesting dividends more in a market downturn), to the right slightly (if you need more current income), or to the left (if you want more growth and don’t need the income).
You need to run your business to benefit YOU the most – there is no “one-size-fits-all.”
This is just a general dividend stock investing STRATEGY (not tactics) and how you can leverage the power of large corporations to pay you a growing residual income stream.
In later articles, I go into the specifics of different dividend stock investment strategies and some of my favorite tools for tracking your investments and monitoring performance.