Jian bing, egg mcmuffin, chinatown, Dundas street west, Chinese food
In a Nutshell: Dividend investing can be a rewarding way to make your retirement more comfortable and secure if you put in the hard work to educate yourself on how to screen for reliable dividend growth companies. Reading The Intelligent Investor is a key starting point to educating yourself in investing. 

Why and how to invest in Dividends.

If you're playing basketball and want to know how to do a proper layup, maybe you'll watch some tapes of Michael Jordan (ok I clearly haven't watched basketball in a very long time), if you want to improve your backhand at tennis, check out how Roger Federer does it, need to get in position better when playing hockey... see how Sidney Crosby does it... what about dividend investing? Go to the master... see how Warren Buffet does it. (SEE AN EXAMPLE OF MY DIVIDEND INVESTING APPROACH AS I EXAMINE BROOKFIELD INFRASTRUCTURE PARTNERS)

WHAT WOULD WARREN DO?

Warren Buffett's company, Berkshire Hathaway, has many ways of making money, one way is by collecting dividends from all the stocks it owns. In the last quarterly report for the period ending Sept 30, 2017, Berkshire Hathaway received $1.68B USD in dividend, interest and other investment income. That's $1.68B USD in three months!
My nose buried in The Intelligent Investor
“By far the best book on investing ever written. - Warren Buffett”
​​That amount of money from dividend income deserves some attention. So let's look at some of the stocks Berkshire Hathaway owns and the dividend yields they pay, based on the ​​ 13F form they filed with the SEC on Nov 14, 2017:
  • American Airlines - 0.84% yield
  • American Express - 1.49% yield 
  • Apple - 1.48% yield
  • Bank of America - 1.8% yield
  • Bank of New York Mellon - 1.83% yield
  • Coca-Cola - 3.24% yield
  • Costco - 1.17% yield
  • Delta Air Lines - 2.41% yield
  • General Motors - 3.41% yield
  • Goldman Sachs - 1.24% yield
  • IBM - 3.9% yield
  • Johnson & Johnson - 2.37% yield
  • Kraft Heinz - 3.14% yield
  • Mastercard - 0.59% yield
  • Mondelez - 2.08% yield
  • Monsanto - 1.83% yield
  • Moody's - 1.04% yield
  • Phillips 66 - 3.02% yield
  • Procter & Gamble - 3.12% yield
  • Restaurant Brands - 1.29% yield
  • Sanofi - 3.68% yield
  • STORE Capital - 5.05% yield
  • Synchrony Financial - 1.77% yield
  • US Bancorp - 2.2% yield
  • United Parcel Service - 2.78% yield
  • Verizon - 5.27% yield
  • Visa - 0.71% yield
  • Wal-Mart - 2.31% yield
  • Wells Fargo - 2.88% yield

None of these companies are overly exciting. They are stable, long horizon businesses that have been around for a long time and will likely be around for a long time into the future. They aren't everything Berkshire Hathaway owns, but they're a significant part of it. Berkshire Hathaway does own stocks with no dividends though that tends to be the exception. The key is that they have been building their positions over time in these dividend paying stocks and reinvesting the dividends to buy more and more stock. It becomes a snowball going down a hill, gathering more and more to where they now get $1.68B USD in just three months from dividends and other interest and income. 

BUT DIVIDEND INVESTING WILL ONLY GIVE ME A COUPLE OF BUCKS

Now you might look up a stock like say Johnson & Johnson (JNJ) and you might see that one stock of Johnson & Johnson pays you only $3.36 USD in a year but the stock costs $138.78 USD. How are you supposed to feel good about a lousy $3.36? Well, you need to look at the history behind it. I'm a long term investor (so is Warren Buffett), so let's look at how a long term investor in Johnson & Johnson would have fared. 

On January 1, 1972, JNJ could be bought for $2.30. Today (Nov 21, 2017) the stock is currently at $138.78. That's a gain of 5,933%. During that time, JNJ paid a quarterly dividend that increased each and every year including during the great financial crisis of 2008/2009. If you held JNJ during that time, though the stock price declined during that time before also bouncing higher, your dividends would have been uninterrupted and increased through that period. That's a stable company, and by investing in it you would have had a stable dividend income source while others were running for cover. And people were running for cover, the world was ending. I remember those days clearly, people thought we were heading for the Great Depression. I don't think the Obama administration gets its fair share of credit for staving off what could have been a real disaster. 

JNJ investors however in the long run had no negative impact if they simply held the stock through that time. That's one of the benefits of investing in stable and growing dividend payers, you don't need to be as concerned with day to day fluctuations in stock price. When you're retired, having reliable income from growing dividends will help you have nights of good sleep even if the market is gyrating. The growth part will help protect you from inflation.

Let's be clear though, you should never put everything on one stock alone. I'm just using JNJ to illustrate a point. Really it should be a portfolio made of many stable dividend paying companies diverse by industry and geographic location.

So what's the gain including the dividend payments? Since 1972, a shareholder of JNJ would have been paid a total of $38.00 cash. So the gain including dividend is a 7,586% gain compared to a 5,933% gain without the dividend. And as of today, you would be receiving 146% of your initial investment, every year! And growing!

But the real magic happens with dividend investing when you take the dividend you get and buy more dividend stock with it and keep letting it snowball or compound as the company raises its dividend every year. 

So what would the gain be if you had bought 1,000 shares of Johnson and Johnson (JNJ) for $2.30 on January 1, 1972?

A JOHNSON AND JOHNSON (JNJ) INVESTOR FROM 1972 MADE 15,087%

If you had bought 1,000 shares of JNJ for $2.30 on January 1, 1972 and:
  • you kept the stock but spent the dividends: You would have 1000 shares of JNJ valued at $138,780. A gain of 5,933%. That's 59x your investment.
  • you kept the stock and kept the dividends: You would have 1000 shares of JNJ valued at $138,780 and cash of $38,004.50. A gain of 7,586%. That's 75x your investment.
  • you kept the stock and reinvested your dividends every year from the year before every January 1 by buying as many whole shares of JNJ as you could with those dividends: You would have 2517 shares of JNJ valued at $349,309. A gain of 15,087%. That's 150x your investment!

That 15,087% gain from 1972 to 2017 works out to an annualized gain of 11.54%, outperforming the market average of 7% by 64.9%. Where else can you take $2,300 and turn it into $349,309 while investing in a stable and reliable non-exciting company?

You have to do your research to find a dividend paying company with a sustainable advantage (or a moat as Warren Buffett and readers of The Intelligent Investor by Benjamin Graham like to call it). It needs to have the right financial ratios shown on their financial statements, so you can determine if it is growing in a way that allows it to grow its dividend every year. Once you find one of those, you have the chance to outperform the market.

The key then to dividend investing is finding sustainable dividend payers, that grow their dividend every year, and then reinvesting your dividends received into more dividend growing stocks. That way you increase your chances of outperforming the market. Also not worrying about the fluctuations in price and holding for the long term as long as the long term operations and strategy of the company are intact.

Some may have panicked and sold JNJ during the great financial crisis of 2008/2009 and missed out on the increasing dividends and eventual increasing stock price. Keeping your head, and paying attention to fundamentals can greatly improve your portfolio's performance.
​​​HOW I BECAME A DIVIDEND INVESTOR

When I first started investing, I knew nothing. I lost plenty of money on 'hot stocks' and on businesses some talking head on tv with whacky sound effects said was a buy buy buy. That's when I decided to educate myself about investing properly. I ordered The Intelligent Investor and when it arrived I buried my nose in it!

It is essential reading for anyone who wants to get serious about investing. It covers essentially everything you need to know. 

Armed with the knowledge from that book and having a much better understanding of how to assess businesses, and having had a chat with my dad about how I don't have a pension, I began to create a dividend income portfolio. 

I did research upon research, used dividend screener tools, poured over financial statements, revisited The Intelligent Investor for clarity. I read the quarterly reports from companies. If possible I checked out the company itself, a trip to a store, use the product or service if possible, look at online reviews. Ask other people their opinions. This helps get another perspective as some products and services may not appeal to you but another segment may be very interested in it. For example, I'm a vegetarian, so I've been looking at YouTube videos and Yelp reviews of Shake Shack to help assess it as an investment.

Dividend investing isn't easy, it's a lot of work. It takes interest and effort. There are easier paths if this isn't for you. You can go for a roboadvisor service like WealthSimple or just get a few key ETFs that give you diversity and market coverage from a variety of providers, Vanguard usually being the cheapest in terms of fees charged. You'll probably do well using that approach and get average market returns. No shame in that. But if you've got the desire to figure out dividend investing it is definitely a doable and rewarding path. I find the key benefit to dividend investing is the income stream that comes with it, without worrying as much about day to day stock market price fluctuations. I feel that when I retire, I want to know cash is coming in the door on a monthly basis without needing to sell any stock.

So armed with that knowledge and the work I had done, I began to buy stocks of dividend payers that I believe could grow their dividends. It wasn't a lot at first. Just a few stocks here and there. The dividends from those few stocks were just imperceptible drips from a tap. Then they started to become louder drips. Then the tap started to flow more readily. Fast forward seven years from when I began dividend investing and that faucet is on its way to becoming a firehose. It now covers all my fixed and discretionary spending and shows no signs of slowing down. In fact it continues to grow and will set me up for a very good retirement. 

So how do you do it? How do you create a reliable and growing dividend income stream?

YOU WANT DIVIDENDS? WELL DIVIDENDS COST, AND RIGHT HERE'S WHERE YOU START PAYING... IN SWEAT

OK, maybe I'm paraphrasing Debbie Allen from FAME, she was talking about fame and dancing, well it applies to anything in life really, and in particular investing. It's not easy, it takes a lot of work and effort... a lot of sweat equity. Get it?

In case you don't know Debbie Allen or Fame... here's the grainy video.
​The first step quite honestly is to get The Intelligent Investor, by Benjamin Graham and read it cover to cover. According to Warren Buffett it is "By far the best book on investing ever written." I couldn't agree more. If you can find it at a library even better. It cost me $25 when I bought it. That's one more stock of Brookfield Infrastructure I could have had. But the book was honestly worth the investment. Go ahead and buy it if you prefer that to the library.

Then get familiar with understanding financial statements. You need to be able to read a balance sheet, an income statement and a cash flow statement and understand at least a few key things:

  • Are the revenues growing?
  • Are the costs growing slower than the revenues?
  • Is there positive cash flow and is it growing?
  • After all expenses like labour and product costs are paid and after all fixed costs like the purchase of equipment and buildings and after paying interest on any debt and after paying taxes and all other expenses, how much cash is left? Is it enough to cover the dividend being paid? Or are they borrowing money to pay the dividend (that's bad)?
  • How much debt do they have compared to the assets they have? Is it too much?
  • How much debt do they have compared to the money coming in to pay down that debt?
  • Has the dividend been growing? Is there enough room with cash remaining to increase the dividend?
  • What about the company itself, is does it have a sustainable competitive advantage? (People who invested in RIM may have been blind to the threat of Apple's iPhone and now the Blackberry is rarely seen. It did not have a sustainable competitive advantage.)
  • Is it a regulated industry and what impact is government policy going to have on the business? Will NAFTA changes impact it?
  • Is there competition that will impact the business either from within the industry or from another industry or from another country? A company providing mail order DVDs initially (Netflix) has done a lot of damage to cable companies, an online book store is doing a lot of damage to retailers of all kinds (Amazon).
  • You have to look at all angles to see how sustainable a business can be going forward. 
  • You also have to look at management. Who are they? Are they trust worthy? Did they hide their cheating on diesel emissions? Do you trust them now? Credibility of management is a key thing as well. See what else they have done, where else they have worked and see how those companies have performed under their guidance.
  • Can you see this company being around and profitable 20 to 30 years from now?
  • How is the company and stock currently valued? Is it overvalued? Undervalued? 
Ok so you've done all that work and now you think you've found a dividend stock you want to buy. 

I HOPE YOU'VE BEEN SAVING

Real basics here, first you're going to need some money. So hopefully you've been doing a good job of living below your means and putting aside lots of savings. In my experience, given I'm terrible at budgeting, the best way to save is to take a big part of my pay as soon as it comes in, and immediately transfer it to my self directed investing accounts. That way it's gone, out of sight, out of mind and I never touch it once I've put it in my investing account. If you wait until the end of the month you'll have no money left to put towards investments. If you take it away immediately, and then freely spend the balance you have left for the rest of month making sure to keep enough to cover your fixed costs and avoid using your credit cards, you should be fine. It's what has worked for me all these years. It allows me to save regularly and allows me to enjoy what I leave in my account. I keep a tally of what will be left after I pay my fixed costs. As I see my balance for discretionary spending getting lower I reduce my spending. 

So the money is transferred as soon as I get paid either into my RRSP, TFSA or non-registered account depending on whether I've used up all the available room or not. I put money in my RRSP first (I'm in a highly taxed tax bracket so for me it makes sense to max out my RRSP), next in my TFSA and then the rest goes into a non-registered self directed account. Based on your own personal situation you may be better off with a different prioritization.

DON'T USE DEBT OR MARGIN ACCOUNTS TO INVEST IF YOU'RE A BEGINNER

A word here, if you're just starting out, don't invest using debt. The bank is not interested in helping your personal finances no matter what they say. They are profit driven corporations. They are great to invest in and collect dividends from, but don't trust them to do what's in your best interests. So the bank may offer you a "margin account", don't take it. They offered it to me when I first signed up, I didn't take it. You want a cash account. Margin means debt with the stocks you hold being collateral. If the stock value declines, you need to pay back some of the amount you borrowed right away, which is pretty tough to do if all your stocks have declined. Just don't do it. Avoid getting a massive debt problem. Only invest with the cash you have on hand. 

So you've set up your investing account, you've found the stock you want to buy and you've got the cash you need to do it... don't buy it yet, don't get excited... just recheck your assessment. Does it really make sense or did you get whipped up to buy it by some talking head on BNN or CNBC, or some article on Yahoo! Finance or some article you found here on SmarterSquirrel? Just make sure it makes sense for you and your own risk profile. How certain are you that this is a good investment. Have you really done a thorough assessment? You worked hard for this money, don't put it in an investment so easily. Think about it. Make sure you believe it's a good investment.

STICK WITH AN ETF PORTFOLIO IF YOU HAVE A SMALL PORTFOLIO

And if you don't have that much money yet, you may be better off investing in just a few ETFs that give you a good diversified portfolio, while you open a mock portfolio on Yahoo! Finance or somewhere else. That way you can make a practice portfolio, adding stocks when you think you would buy them and logging the price you would buy them at and seeing how you perform without putting any real money at risk. Having a small portfolio invested in just a couple of stocks means you are at risk of losing a significant portion of your money if just one stock tanks. A good ETF portfolio would be comprised of holdings in Canada, the US, International markets and a little bit of fixed income or bond investments.  

Another word here, if the bank offers to put you in mutual funds, don't do it. Look for the lowest cost investing option you can find. If the average market return is 7% and you get put in a mutual fund taking 2% or even 1% as fees, they are taking 14% to 28% of your potential gains! Why should they get that? Go for very low cost ETFs from providers like Vanguard.

OK, so you've got a big enough portfolio now and you've taken the time to educate yourself by reading The Intelligent Investor and learning how to read financial statements and understand the story they're telling you, and now you're ready to start investing in individual stocks. 

Please don't buy individual stocks if you haven't done that work. You may as well throw darts at a board filled with stock names with your eyes closed. 

AS YOU BUY DIVIDEND STOCKS BUY ONLY A PORTION AND GO FOR DIVERSITY

Keep most of your portfolio in your ETFs. Take a small amount and get ready to buy the stock you want. Don't buy the whole amount of shares you want. Nobody is clairvoyant enough to know where the bottom or the top of a stock chart is going to be. But make sure when you buy a portion, that you believe you are buying at a reasonable valuation based on your assessment. Buy only a portion of your final position at a time. If you want to own 1000 shares maybe buy half or a quarter of the position at any one time.

As an example, I've been buying Brookfield Infrastructure Partners (BIP-UN.TO) in regular increments since 2012 when I first bought it at about $20.46 CAD (split adjusted). I most recently bought it at $56 CAD. Today it is at $55.30 CAD. Everytime I buy more, I review my assessment to make sure the story is still intact. When I first bought it, it was paying an annual dividend of $1.00 USD (split adjusted), today the dividend is $1.74 USD, up 74% in 5 years. 

As you buy dividend stocks make sure you are keeping a few things in mind. You want geographic diversity. If all your dividend stocks are from Canada and they get all their revenues from Canada, you have not diversified geographically. Try to make sure that your entire portfolio of stocks gets its revenue from a diverse geographic area. For my portfolio I tend to aim for 1/3 from Canada, 1/3 from the US and 1/3 from outside North America. 

Also diversify your holdings by industry. If all you own are bank stocks, then your portfolio is in danger if something happens to the banking industry. If all you own are oil stocks, then you're really in danger of a rapid shift to electric cars and alternate energy. Try to get a good spread across financials, technology, healthcare, REITs, consumer discretionary and staples, biotech, agriculture, resources, industrials, infrastructure, utilities and telecoms, etc...

KEEP CHECKING ON YOUR STOCKS TO MAKE SURE THE STORY IS INTACT

Also make sure the reason you first bought it is still intact. If not assess whether you should sell and get out of your position.

If it makes sense to continue holding, then as you get your dividends paid to you, take them and add more of your savings to them and buy more dividend stocks that pass your assessment criteria. 

If you do this, and put in the hard work it takes, then you should be able to build a reliable dividend income stream that grows larger and larger over time.

THE PAY OFF POTENTIAL OF INVESTING IN DIVIDENDS

For example, if you start with $10,000, adding $10,000 every year for 30 years, and are able to invest in a portfolio averaging an initial 4% yield, with average dividend growth of 4% and average capital appreciation of 4%, in 30 years you will have $1,125,521 and a dividend income of $45,021. That's from your cash input of $300,000. That's a pretty good deal.

Of course if your portfolio of dividend income stocks raise their dividends more quickly, your dividend income will compound and grow more quickly. 

The average Canada Pension Plan payout is $653/month today, and the maximum you can get is $1,114/month. That's $7,836 to $13,368 annually. Assuming you've got a partner, that doubles to $15,672 to $26,736 for the two of you. Yes...that's it! That's not much of a plan is it? Really it should be called the Canada Pension Supplement to Whatver Else You've Got Planned Because You Sure Can't Live On Only This Pittance.

Let's assume we've run out of money for OAS by then. That's not much to live on. If you don't have a work pension to add to that amount you'll be in trouble. Having a dividend income stream of $45,021 to add to it will take you to between $60,693 to $71,757. That's a lot more comfortable than you would be without a dividend income stream.

Of course you can always save more and invest more. If you can do $20,000 initially and $20,000 a year that will get you to a dividend income of $90,000 in 30 years. Add in the CPP and you're over $100,000 income in retirement. Now you're really ready to enjoy!

Assuming there's two of you, that $20,000 you need to put aside each year is $833/month each or $27.40/day. Think about that the next time you're looking at buying a brand new car, or a $1000+ purse you don't need, or that $30 bottle of wine that doesn't really taste that much better than that other $20 bottle of wine, or that thing you think 'today you' needs that will mean less money for 'tomorrow you'...  


Be a SmarterSquirrel... Save. Invest. Enjoy.


​Remember to sign up for the SmarterSquirrel Monthly Newsletter and to follow me on Twitter so you get updates when I publish a new blog or when I add stocks to the SmarterSquirrel Mock Portfolio.

Lessons Learned:
  • If you don't have a lot, don't invest in individual stocks, invest in a portfolio of ETFs giving you good diversification of industry and geography
  • Educate yourself in investing by reading The Intelligent Investor by Benjamin Graham
  • Learn how to read financial statements
  • Make a practice portfolio to try investing without risking actual money
  • Dividend investing can help outperform market averages
  • Dividend investing can provide a somewhat reliable income stream that makes your retirement more comfortable
  • Don't use debt to invest and avoid expensive mutual funds
  • Assess dividend income companies and if you feel they meet your criteria after educating yourself, buy in increments and create a diversified portfolio of dividend stocks
  • ​Reinvest your dividends into more dividend income stocks to maximize compounding
  • To see my approach in action with an actual stock click here
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