Dividend investing remains at the very heart of the Bedokian Portfolio investment methodology; after all, the mantra at the top of the blog read “Passive Income Through Dividend and Index Investing”.
Before I delve into the intricacies, I would like to state that this is not a “this is good, others are not good” type of post. As seasoned readers of this blog had noticed, I am open and go into index, value and growth as well.
Part Of Returns
It is universally understood that returns of an investment are consisted of two parts: capital gain plus income. What could be easily missed by investors is that, unlike the capital gains part where it is obtained with the liquidation of the investment, you can earn the income and hold the investment simultaneously. In other words, capital gains are unrealized gains, whereas income is realized. In this way, you can continually hold the investment and benefit from the payout, which could be put into good use.
Powder For Reinvestment
Speaking of good use, reinvesting the income into the same counter or other counters will amplify the compounding effect which is so exalted in investment circles. Buying into other dividend-generating instruments will create more of the returns = capital gain + income models, and the income parts of these instruments will have more opportunities of reinvesting, and so on.
Another good use is that in the event of retirement (conventional or early), dividends form a major component of passive income (we shall reserve the semantics of “passive” for another day? ), without the need for capital disposal, from an investment portfolio. If managed properly and given your preference, dividends can continually fund your lifestyle and the portfolio can remain intact for your eventual beneficiaries.
There is a general understanding that there is a positive relationship between inflation and dividends from equities. The rationale behind this notion is that during inflationary periods, prices rise and this translates to a rise in company profits, resulting in a rise in dividends. For this, I would say my favourite phrase: it depends. Some sectors/industries and companies are positively correlated to inflation, like those that deal with energy, commodities, etc.
As with all methodologies, there are bound to have caveats and disadvantages of dividend investing. The obvious one is dividends are not guaranteed, in terms of the amount and the payout. Companies can cut down or even suspend dividend payments due to change of dividend policies, economic conditions and/or regulatory requirements. Another disadvantage is dividend counters are deemed to be low growth, i.e., not much capital gains. This is in line with the stable and matured characteristics of dividend-producing companies.
Despite the caveat, I am still all for dividend investing. If you are comfortable, include some growth1 and/or index2 counters to alleviate the low capital gains issue. On top of this investment style and methodology, it is also prudent to keep a diversified portfolio of various asset classes and rebalance accordingly. Do not forget that there are other income-producing instruments such as bonds, treasury bills and bank deposits.
1 – The Bedokian Portfolio (2nd Edition), p149
2 – ibid, p135 – 137