Regular readers of this column know that I'm a big fan of dividend growth investing. It's a subject very close to my heart – and my wallet.
Having invested in dividend stocks for more than a decade, I can tell you I'm very pleased with the results. I've also heard from scores of readers – many of whom have been at it much longer than I have – who can attest to the merits of this simple but powerful strategy.
For my next two columns, I'm going to step back from the company and fund analysis that usually appears in this space and talk more generally about dividend investing. Today, I'll explain why, in my opinion, it's an appropriate strategy for many do-it-yourself investors. Next week, in the interest of providing a balanced picture, I'll discuss some dividend investing myths.
Here are five reasons to love dividend growth investing.
It's easy to understand
Many people find investing too daunting to try on their own. But the idea behind dividend growth investing couldn't be simpler: If you invest in a diversified basket of companies with a track record of raising their dividends, your income will grow over time and so should the share prices. So you win two ways.
I've heard the argument that this amounts to "rear-view mirror" analysis. While it's true that a history of dividend increases doesn't guarantee that hikes will continue, a strong dividend growth record is a shorthand way to identify companies that generate lots of free cash flow, have a competitive advantage and are focused on generating wealth for shareholders.
It discourages trading
The prospect of receiving a dividend is a powerful incentive to stay invested. This is important because numerous studies have shown that frequent trading – with its high commissions, taxes and emotionally driven decisions – is harmful to your financial health.
Every dividend rewards the patience of the investor, and every dividend increase is confirmation that the strategy is working. In my own portfolio of 21 stocks, all but two have raised their dividends in the past 12 months. If I'd sold any of those stocks, I would have missed out – which is one reason I do very little trading.
It's well-suited to lazy people
I admire entrepreneurs – people who take risks, work gruelling hours and create jobs for others. Unfortunately, I don't have an entrepreneurial bone in my body. But thanks to dividend stocks, I can own a piece of a great business and draw a quarterly "salary" for doing jack squat.
This week alone, I'm getting paid by Johnson & Johnson, Canadian REIT, McDonald's, Inter Pipeline Fund and Pembina Pipeline for sitting on my fanny. It's tough work but somebody's got to do it.
It protects you from inflation
Bonds and guaranteed investment certificates are a great way to provide stability to your portfolio. Everyone should own some. The problem is that the income they throw off doesn't grow over time, so you're exposed to the wealth-destroying effects of inflation. Many fixed-income investments currently yield less than the inflation rate, so you're losing money on a real basis.
Dividend growth stocks, on the other hand, pay you a rising income that counters the effects of inflation. McDonald's, for example, can raise menu prices to cope with higher input costs, and Canadian REIT can charge higher rents to its retail and office tenants. So your income grows on an after-inflation basis.
Studies have shown that dividend-paying stocks outperform non-dividend-payers, and that dividend growers perform best of all. RBC Dominion Securities examined the period from 1986 to 2011 and found that dividend growth companies produced an average annual total return of 12.7 per cent, compared with 7.3 per cent for the S&P/TSX composite index and 2.4 per cent for stocks that paid no dividends.
What's more, other studies have shown that dividends account for more than half of the stock market's total return over long periods. In fact, the contribution from dividends may be as high as 90 per cent. (See Daniel Peris's book, The Strategic Dividend Investor: Why Slow and Steady Wins the Race). That's why, when I buy a stock, I demand a dividend.