This article is Part 3 in a short series of blog posts where I will lay out my business and investing strategies at a bird’s-eye level. The Rich Dad books talk about focusing on what you’re good at, but diversifying in terms of the type of asset you own (as opposed to diversifying across industries within one asset class). I’ve taken that concept and applied it to my own passions, as well as the knowledge I’ve gained from all of the reading and research I’ve done over the past couple of years, to determine just what business and investing vehicles I plan to use and how I plan to leverage them.
This article talks about how I plan to augment my investing portfolio in the “PAPER ASSETS” asset class by purchasing dividend-paying shares of large, well-known, powerful, stable and sustainable companies.
When you hear someone talk about “investing,” what are your first thoughts? If you’re the average person, you probably think about the stock market. Investing in stocks is by far the easiest way to quickly start investing your extra money, and you don’t really need a lot of capital to get started. In fact, most people seem to think the only real investment vehicle out there is owning shares of stock – I know it used to be the only thing I would think of back when I wasn’t very “financially educated!”
Trying to “play the stock market” can be a majorly risky gamble, but there are other strategies by which you can make a very conservative, stable investment that will surely grow over time.
The Place in My Portfolio
I said it above: done right, stocks are a very conservative, stable investment that will grow over time.
Most people use mutual funds in their 401k as a retirement plan. They put money away into that plan, hoping to start withdrawing from it once they reach retirement. Until then, the “asset” is not touched. It’s not a “getting rich” tool, but rather a way of using money you’re already receiving to create a new source of income later on. Of course, mutual funds are a terrible investment: they’re actually designed to make the mutual fund company rich at the investor’s expense.
However, I do plan to use dividend stocks in much the same way as the Average Joe uses mutual funds. I don’t mean in the sense of a retirement plan (I don’t plan to have a traditional “retirement,” but rather a life of “work when I want on what I want”), but rather, that it will be my most conservative investment vehicle. Unless I have some stroke of luck, and one of my stocks happens to skyrocket, I probably won’t get rich from stocks alone. But by funneling excess cash from my other businesses and investments into stocks that I’ve determined to be successful, I’ll be able to create a solid foundation of stable-but-growing passive income from the ever-increasing dividends those stocks will pay me.
Most people think “investing” in the stock market (most people probably don’t really consider their mutual fund-based retirement plan to be a form of investing) involves what is essentially market-timing. They believe the only truly successful way to make it big in the stock market is to find that next Microsoft, Apple, or Google before anyone else does – to make exponential gains from a nobody. At a more “conservative” level, a stock market investor might hope to buy some stock at the bottom of the market and re-sell a few weeks later when the market hits its peak – holding a position for only months, weeks, or sometimes even days. But where is the bottom and where is the top? Without sophisticated HFT algorithms, that’s not easy to figure out, and, from my perspective, this sort of “investor” relies a lot on luck – much like the house-flipper or sports-better that I mentioned in Part 2 of this series! The problem with these strategies is that it’s difficult, if not impossible, to beat the market (after all, the market is an “average” of gains and losses).
But there are much more conservative strategies to stock market investing that don’t rely on market-timing and capital gains. It’s a lot easier to track the market in terms of value, and even net a return through cashflow. For the ultra-passive investor, you can buy index funds that track the overall market. This strategy is more of a store of wealth – you won’t ever lose, but you also won’t ever win. Another strategy is to buy dividend stocks. This doesn’t mean finding the company with the highest dividend yield (or annual return percentage) – these 10% and 20% yielders are actually often on the verge of failure. It means buying shares in powerful, stable companies that have been successful for a very long time and will continue to be successful for a very long time. These are the Microsofts, the Wal-Marts, the Coca-Colas of the world.
Strong dividend champion companies like I mentioned above are able to weather the storm in both good times and bad. The price tends to track the market pretty well, too – so, since the market goes up on average over time, so will the overall value of your portfolio. But that’s not where the real magic happens. You’re probably not ever going to get “exponential growth” from these huge companies – they’re not really putting effort into growth, but rather, they give their excess cash back to their shareholders in the form of dividends. Even better, the best of the dividend champions tend to increase their dividend by something like 15% annually!
Let’s do some math. Say you purchase a single share of a dividend stock at $50, and it yields 2% (for the sake of easy math), returning $1 to you in that first year. As I said above, these companies like to raise their dividends by around 15% each year, so the next year you actually get $1.15. Based on just dividend increases alone, by the end of 30 years, that original stock will be paying you $50 annually – a 100% yield on the original investment!
Now let’s introduce the concept of DRIP, or dividend reinvestment plans. The idea is that, whenever the company pays you a dividend, you don’t even touch that cash – it immediately goes back into buying more of the stock. This creates compounding returns, as you’re now getting a 15% increase in dividends each year, and you’re yielding a return on more stock than you bought in the first place. With the same $50 stock enrolled in a DRIP, you’ll end up with a whopping $377 dividend annually at the end of that same 30 year time period for a 755% annual return on your original investment.
It gets even better when you start dollar-cost averaging your investment – this simply means buying over time, rather than in one bulk chunk up-front. This allows you to average out the highs and lows of the market: you won’t be able to take advantage of the lowest price, but you also won’t find that you accidentally bought too much stock at the peak of the market, and you don’t have to worry that it will never reach that price again. There are multiple strategies even within dollar-cost averaging – some people simply buy stock with a certain percentage of their paycheck at each pay period, while others might buy a certain number of shares periodically. You can decide to automatically purchase a number of shares of each stock in your portfolio each month, or you can spend the entire amount on just the stock that’s most attractive to you at the time – and anything in-between!
My personal strategy will involve funneling any excess cash from my other businesses and investments into whatever stock is most attractive at the time. I have a few stocks that I’ve researched and have determined I want to buy the stock, and then I monitor the prices of these stocks to have a sense of what is a good buy. Whenever I have excess cash, the rule is to invest it in something – my form of dollar-cost averaging doesn’t necessarily mean that I always invest in the stock market! If there are other, more attractive options, I may choose to pursue those instead. In fact, right now, I have only a few stocks – since the stock market is at a high (and possibly even in a bubble) at the time of writing this (and has been since I started focusing on investing) while interest rates on capital and loans are at an incredible low, I’m actually saving my cash to hopefully purchase another piece of real estate near the end of the year. Sometimes, one my selected stocks will dip pretty low and I’ll grab a few shares, but overall, I try to have a sense of the whole market and all asset classes when investing. When things change, and the stock market hits a low, I might be more interested in buying up cheap shares of stock in bulk.
Steps to Buying Dividend Stocks
Buying stocks is actually probably the most straightforward and simple form of investing. As with any investment vehicle that is worth pursuing, it does take some time and effort up-front: you have to do some research to determine what stocks are worth buying. Once you own the stock, though, you just sit back and collect dividends.
The steps to buying stocks are:
- Find a Company Worth Owning. This is the part that takes the most effort. Once you find a stock that seems attractive, you need to do some more research to determine if it’s actually worth buying – some seem like it at first, but turn out to be duds! You need to go over financial data, income statements, and balance sheets to make sure that the company is strong, and to determine that it will, in fact, be able to increase its dividends by quite a bit for years to come.
- Dollar-Cost-Average. You’ll need a consistent dollar-cost averaging strategy, and you’ll need to stick to it. Buy up shares according to this strategy continuously until you determine that either the stock is no longer worth buying or even worth selling.
- Monitor the Market for Changes. Keep track of the goings-on of each stock you own and each stock you want to own. You’re probably not going to keep up with everything going on within the company at this stage like you would during step 1, but you want to know quickly if anything changes within the company or the stock – if it suddenly becomes more attractive, you might want to buy more. If the dividend gets cut or the company goes through some hard times, you may need to make a judgement call. The ultimate goal with dividend stocks (and any cashflowing asset) is to hold them forever and milk that sweet passive income, but sometimes it might just not be a good investment anymore. You might decide the company isn’t worth buying more shares of, but that the dividend is still nice enough to hold onto what you’ve already got. You might also feel nervous about the company’s future and decide it’s worth selling. You have to prune your portfolio or else it will get out of control!
- Wait. The most important part of a dividend stock portfolio is time. Between dividend growth, DRIP purchases, and dollar-cost averaging, you should end up with a massive portfolio if you just stick to it. After many years have gone by, your stocks will be yielding a pretty sweet passive income through dividends! You don’t get to reap the rewards immediately, but it pays off in the end.
- Enjoy Your Returns. Eventually, you can decide that your dividend yield is high enough, and you can stop investing into the portfolio and just let the passive income from your dividends roll in. Some use this money for retirement, quitting their jobs in old age and just enjoying the cashflow. I plan to be rich already long before then; in fact, I may not ever need these dividends, and might simply have them accumulating and growing as a back-up plan.
That’s it! Six easy steps. You won’t get rich quickly, but you’ll be able to accumulate wealth over time with this method.
Get to It!
The stock market isn’t about market-timing or beating the market — unless you work on Wall Street. There are much better ways to attain consistent wealth over time. I prefer the cashflow strategy of accumulating dividend stocks – powerful, stable companies that have already proven themselves over the years. This is said to be the most consistently viable way to accumulate wealth in the stock market.
There are, of course, upsides and downsides to every form of investment. Owning dividend stocks takes a lot of the headache out of investing, since once you own the asset there is next to no extra work to be done – no system to automate, etc. However, you also aren’t going to have the same potential for a return on your investment. Since you own a very small fraction of the underlying asset – the company you own shares of – you have very little control overall. There is nothing you can do to increase the value or the cashflow of a share of stock, whereas you can always do some repairs on a home or add features to a software product to increase its market value. That’s why stocks are an ultra-conservative investment – you want to find strong, stable companies that aren’t likely to go under in order to keep a stable base of your wealth as a back-up plan.
That’s how I plan to find cashflowing assets in the stock market. What are your plans?
This is just Part 3 of the Getting Rich Through…. series. Stay tuned for the rest!