Welcome to my latest dividend income update for 2016. For those of you new to these posts on my site, every month I discuss my approach to investing using Canadian dividend paying stocks and Exchange Traded Funds (ETFs), and how reinvesting the dividends and distributions paid from these Canadian holdings are helping us reach financial freedom.
Dividends are good but let’s be clear: dividends can disappoint.
Even though my thinking about dividend investing has not changed for many years, it’s not all roses. Dividends can be cut or eliminated. Look at Dream REIT (D.UN) this year. Hopefully that’s rare for your portfolio if you own it!
With this risk provided let’s also revisit why corporations have paid dividends. It’s not as straightforward as you might think.
In a perfect world, all businesses would allocate capital in a way to perfectly maximize the return on that capital. This would be done so reinvested money would go back into the business in way that pays off immensely for the shareholder (by increasing returns over time AND by continually reducing the company’s tax burden). As you know, we don’t live in a perfect world.
The link I provided above tells us shareholders like optionality – and dividends provide that optionality – to give them the choice to increase or decrease their exposure to the business. Reinvested dividends therefore, take advantage of that optionality, to increase exposure. Dividends taken as cash, do not. The former is something I do, often, although there are never any long-term guarantees about the success of any business. This is why regardless of what you do with your dividends you must diversify across companies and sectors and countries if you want to hold individual stocks. Otherwise just learn to live with stocks for a low fee via index investing and be the market; owning good and bad stocks and everything in between.
Thanks to the Canadian companies we own in particular, that pay dividends, we crossed a new milestone this month. We’re on pace to earn just over $13,000 in dividend income this calendar year – money we don’t dare touch because it’s earmarked for our financial future to pay for expenses when we’re not working someday.
Getting paid and getting some raises from time to time for doing nothing but staying invested – is part of the optionality equation shareholders have demanded as part of our modern economy. Dividend investing provides cold hard cash into our bank account that we will eventually use. Dividends are not magic, dividend investing is not without some risk, but they are good.