I am building a decent follower base on Twitter and that gives me the opportunity to interact with investors from different backgrounds, with different mindsets with different set of questions. Some of these interactions are particularly interesting where questions center around whether dividend growth investing is a meaningful strategy towards reaching financial independence.
I know the personal finance community on social media can get very confrontational at times with their general discourse. A natural response that I see from folks who are questioned is to get defensive, start taking the questions as a personal attack and classify the questions as “hate” or “trolling” or whatever.
I take a slightly different approach. If the question that is posed has some sense of rational basis to it, I want to think about it and answer it. Investing can be a pretty lonely endeavor. And it is natural to question your approach and think about whether your strategy is right or not. And as an investor, it is easy to slip into an echo chamber and block out all arguments that are contrary to your way of investing. But IMHO, this is not healthy.
A solid investment strategy is one that can withstand the counter punches of critics. And so from that viewpoint, I value criticisms because they force me to deeply introspect about my investing strategy.
Note: These are actual questions/criticisms that have been posed to me either directly (through DMs/email) or indirectly (addressed to the dividend growth investing community at large, of which I am a part of).
So with background out of the way, lets get to the questions/criticisms…
Criticism #1: Most dividend growth investors are investing in a company simply because it is paying a dividend. Some of these companies are not even growing and are under-performing the broader market. Aren’t these investors having a myopic view, being blinded by the dividend income, but vastly under-performing the broader market in terms of total returns?
There is some merit to this question. Yes, dividend investors can be blind-sided by the dividend yield of a particular company and invest in that business solely for that reason. But there are similar parallels with other investing strategies as well. With the so-called “growth stocks” you are also investing in companies that are largely unprofitable at this moment and buying into the narrative of promised future growth. Same deal with real-estate. And don’t even get me started with cryptocurrency and other speculative investments!
So almost all strategies when not used correctly can lead the investors into making bad decisions. So where does the flaw lie in this reasoning?
The answer lies in “growth” aspect of the dividend growth investing strategy. Most dividend growth investors ought to be focused on not just the current dividend yield but the safety of that dividend in the near-future and the possibility of a growing dividend several years into the future. And to guarantee that, they need to consider the cash flows, revenues and the strength of the balance sheet for those businesses.
And not all dividend growth stocks will grow the same way, some grow slower but offer a higher starting yield, some grow faster but offer a lower starting yield. Some grow unevenly/cyclically because of the nature of the sector that the business belongs to. But all these stocks work together as a part of the cohesive portfolio to generate meaningful returns in all kinds of economic environments.
Criticism #2: You are using dividend growth investing as a strategy to generate passive income, that is because you are either not successful or simply don’t know how to generate passive income through other means. You can just as easily earn passive income through other means.
Ummm..sure. Yes, I could just as easily earn passive income through some other means. No disagreements there. It is just that dividend growth investing seems to fit the bill the best in-terms of being hands-off, offering meaningful growth and letting me sleep well at night and focus on my regular job during the day. If I have found this and it is working for me, why should I continue looking for something else??
Criticism #3: Dividend theory is nonsense and is a topic for newbies. Dividends are irrelevant because the stock drops by the same amount as the amount of dividend being paid.
Agree that act of a business paying the dividend is irrelevant as far the stock price action on the day the dividend is being paid. However, to extend that argument and then state that the dividend policy itself is irrelevant is fallacious. Dividends form a significant part of the total returns generated by any business and any argument that states otherwise is missing the point completely.
Criticism #4 :You individual stock pickers really think that you would be outperforming the broader market? Do you even know how many stock pickers have been able to achieve this? I am sure your portfolio under-performs the broader market index. You could have simply invested in a index and been better off.
Here is the thing: While my focus on this blog is about dividend growth investing and my dividend growth portfolio, a large portion of my net-worth is also tied with low-cost index funds. They both serve dedicated purposes. My dividend growth portfolio is something that I am using to build a reliable stream of passive income that will one day be used to pay my bills. The funds tied up with index funds form the bedrock of my retirement and can/will be used for other retirements needs.
My point is you can very well be both an index-fund investor and an individual stock picker at the same time!
Now, regarding the question on whether someone should be picking individual stocks. I invest in individual stocks for a specific reason: to generate dividend income. Investing in a index fund like VOO, Vanguard’s SP500 Index fund ETF, would only yield ~1.6%, at the time of writing this, a yield that is far below what my portfolio is generating currently.
One can make the case of investing in an dividend growth ETF instead of picking individual stocks. There is certainly merit in this argument and for this reason, I too hold some ETF investments in my portfolio. Having said that, I have explained a few drawbacks with investing with ETFs on this blog in the past.
On the question of performance w.r.t the broader market, we are really comparing apples to oranges because my goal is to generate passive income through dividends and not measure capital appreciation alone. That said, several stocks in my portfolio are also a part of the SP500 index as well.
Criticism #5: These dividend investors keep bragging about their monthly dividend income. It is more like a status symbol and/or means to build a social media following and clout.
This criticism and the next one came from a YouTuber called Brad Finn who owns a channel on YouTube to discuss personal finance topics, option trading, futures trading etc.. He has a decent following on that medium. Brad recently sold his dividend growth portfolio completely. Oddly, he says that this is the second time he is selling out of this dividend portfolio completely. This is not a personal attack on Brad or anything, because anyone can change their mind about what they want to do with their investments. But something that he said about this struct me as very odd.
“I know it makes for great videos, but if I was not a YouTuber, or a (air quotes) influencer….would I really need a dividend portfolio?”
I have seen similar comments from other critics as well. I don’t know where this is coming from, but I want to make one thing amply clear: I certainly am not doing this for gaining subscribers or gaining more social media followers. For the same reason, I do not have any affiliate marketing links here. I am genuinely not interested in making money from this blog or anything like that.
To the contrary, the primary purpose of this blog is to motivate you, the reader, in your journey towards financial independence, irrespective of whether the journey happens to be via dividend growth investing or some other investing strategy. Everyone’s situation and goals are slightly different and it would be naive of me to proclaim that dividend growth investing is the ONLY strategy that works for everyone.
Funnily enough, while you have one set of critics who think folks only like to talk about dividend growth investing because it is cool, there are a separate set of critics who like to think that dividend growth investing is the most boring thing in this world. Who is right here? Neither, of course.
Criticism #6: With dividends received, you are realizing forced income and paying taxes for it. Why even bother with that especially for income that you do not need right now? Couldn’t you instead invest in something that does not have this forced income, like an ETF like VTI, grow that unrealized and only begin investing in dividend stocks closer to retirement when you actually need this income.
Brad Finn brought up this question on a separate video and I think it is a good one because I have seen the same argument brought up by other critics. The rationale for the argument is sound (atleast on the face of it): if you do not need that passive income right now and you would only need it in the future, why realize it now and pay a forced tax on it. However, the argument has several flaws and let me attempt to debunk each of them.
So the first flaw in this argument is that even with investing those funds in an ETF like VTI, I would still realize some forced income because VTI also happens to pay dividends/distribution.
The second flaw is that when I would need those funds to invest in individual dividend stocks closer to retirement, I would need to sell some of my VTI stock to gain access to those funds. Depending on the gains, this could be a significant tax event. But more importantly, what is VTI were to drop like 20% closer to my planned sell date due to a recessionary economic environment and the stock market would never recover for the next decade. This would mean that the amount of capital available to me to deploy towards dividend stocks would be that much lesser, meaning my generated income would be lesser as well. Arguably, I might be able to buy stocks with higher dividend yields , but this depends on the stocks I am planning to purchase. My point being: it is not as straightforward as it sounds in theory.
Perhaps the biggest flaw in this argument is the lack of understanding of the concept of Yield-On-Cost. This is a subject that I covered during the early days of this blog. Simply put, with companies that grow their dividend at a decent clip, it is not the starting yield alone that matters, but rather the compounded yield available after several years that matters more to the investor. This highlights the value of a dollar spent 20-30 years prior to today i.e. what is the compounded yield that my capital deployed 20-30 years ago generates as of today. I had used Visa (ticker: V) as an example in that computation and showed how after 30 years of compounding the simple yield on cost amounts to 77%. It would be impossible to find that high of a starting yield.
I understand Brad’s frustration with the taxes on this forced income. But he is also big on earning passive income through option premiums on covered calls, wheel strategy etc. I find it odd that he is complaining about taxes on dividend income, when in fact taxes on option premiums are worse, they are treated as ordinary income and taxed higher.
IMHO, dividends are a tax-efficient form of passive income. Atleast in the US, at the time of writing this, qualified dividends are taxed as follows if you are married and filing jointly:
If you make under $89,250 in qualified dividends, you pay 0% tax! That’s right, 0%.
This becomes even more impressive if you add in standard deduction limit of $27,700 i.e. $89,250 + $27,700 = $116,950. So you pay 0% tax on ~$117,000 of qualified dividend income for the year.
Once again, I welcome counter-criticisms regarding this strategy, it has its nuances to grasp and it can be very misleading. But when you see the compounding in action, it finally “hits you”. Atleast that was what it was in my case.
As always, drop in your comments if you disagree/agree. But please do so respectfully without engaging in needless mud-slinging.