When people ask me why I’m so passionate about dividend growth investing, my answer is relatively straightforward: because I believe that this investment strategy is the simplest, easiest, and most efficient way to reach financial freedom.
To me, at the most basic level, financial freedom means I have reached the point where the passive income that my assets (namely my investment portfolio) generate is larger than my expected lifestyle expenses.
Now, there’s obviously a bit more to it than that.
For instance, I also need to be sure that my passive income stream is reliably growing at a rate that exceeds annual inflation.
This means that the purchasing power of my passive income stream is maintained, and even increased, over the long-term, rather than being eroded away by inflationary forces.
In retirement, I find this to be extremely important because no one wants to run the risk of outliving the income their portfolio generates.
As healthcare and technology improves, I expect life expectancies to continue to rise. And, I want to put myself into a situation where I can enjoy a long and happy retirement, no matter how many years I’m blessed with here on planet Earth.
Thankfully, this aspect of financial freedom is easily achieved by a well diversified dividend growth portfolio, which, depending on one’s target yield, can reliably generate annual dividend growth that is double, triple, or even quadruple the traditional rate of inflation (which historically, has hovered between 2 and 3%).
Also, when thinking about financial freedom, I want to make sure that I have at least 6 month’s worth of savings in an easily accessible and highly liquid form.
Why? So that in the event of an emergency that results in an unexpected expenditure, I am prepared to pay it without totally disrupting, or worse, dismantling the financial situation I find myself in.
But, things like an appropriate amount of emergency savings, one’s lifestyle expense expectations, one’s target retirement date, the yield that someone feels comfortable living off of (generally speaking, the higher one’s portfolio yields, the most risk they’re facing), and the savings rate required to amass enough capital within a set amount of time to generate one’s target yield will all highly individualized.
These personal finance metrics will vary from person to person depending on lifestyle choices in the past, present, and future.
There’s no way that I could cover the myriad of factors that need to be considered in retirement planning in a word count that would be enjoyable to consume.
Because of the extreme variance at play here, I’ll simply say that the first step to financial freedom is living below your means.
Refusing to make the sacrifices necessary to live below one’s means is the first big mistake that people make when it comes to preparing for retirement. If you’re unable to do this, then frankly, you’re very unlikely to be able to experience a comfortable retirement. However, being that this is an investment article, I imagine that you’ve already checked off this first, very important box, because if you aren’t living below your means, then you likely don’t have funds available to invest.
So, let’s say that you are someone managing money in the markets…well, then it’s time to move onto the second very big mistake I see individuals make that can totally derail their retirement plans: allowing emotions to dictate trading activity.
In value investing 101 the first lesson that students are taught is to “Buy low and sell high.”
That sounds pretty reasonable, doesn’t it? Easy, even. Unfortunately, for many individuals following this simple two step process to generate wealth doesn’t work out so well. Actually, the majority of investors tend to do the exact opposite (they buy high and sell low).
Why? Because of human nature.
We’re flawed, emotional beasts. Fear and greed are two of the most powerful influences over the human mind and these two forces are what drive the vast majority of market moves in the short-term.
Over the long-term, the underlying fundamentals that companies produce rule the day. However, markets aren’t totally efficient and investor sentiment is what drives share prices in the present.
The fact of the matter is, when most people see share prices rising…when they see others making money…when they see others getting rich…they begin to feel a sense of FOMO (the fear of missing out).
It doesn’t matter if the trade that is generating this short-term wealth is rational or not. That’s not what most people are focused on. They don’t care about the fundamentals. Instead, they’re focused on the momentum because of…you guessed it: greed.
Investors chase momentum all of the time. And, the practice creates a self perpetuating cycle because as asset values move higher, more and more people experience FOMO, which increases demand, which increases shares prices, which creates more FOMO, which increases demand, etc, etc, etc. You get it.
Sometimes, this situation leads to a Greater Fool’s Theory situation, where people completely lose sight of fundamentals and foolishly buy shares of something, assuming that an even greater fool will be more than happy to buy them at a later date for a larger price.
Well, as the old saying goes, “You know what they say about assuming.”
This is what leads to bubbles forming…and when bubbles form, there are only two likely outcomes, neither of which are good for shareholders.
One, the share prices of the equity(ies) caught up in the bubble stagnate for very long periods of time as their underlying fundamentals catch back up and eventually justify their prices.
Or two, the bubble pops.
When this happens, asset values fall precipitously.
Why? Because when share prices begin to fall and investors realize that there is no fundamental floor beneath them to support a soft landing, they experience fear.
No one likes losing money, afterall.
And, in situations like this, fear takes over and creates a self fulfilling cycle of negativity that oftentime leads to irrationally low share prices.
Eventually, shares caught up in this fear-driven negative cycle tend to trade down to levels where their underlying fundamentals begin to support a rational valuation. But, when that time comes, fear has already clouded the minds of many investors who’re unwilling to look at the data due to their fearful focus on the negative momentum.
You’ll hear people say things like, “Never try to catch a falling knife.”
Well frankly, I totally disagree with that sentiment.
If a “knife” has plunged so far that it is supported by strong fundamentals, the risk of being cut is far less than the combined upside of capturing future fundamental growth and multiple expansion via mean reversion.
(If you’re a value investor like me, you tend to believe that all things revert to their means, given enough time.)
Yet, most people don’t see it that way. They’re too concerned with the short-term rather than a longer-term outlook.
As you can see, share prices are oftentimes a roller coast of sorts, driven by irrational momentum, both up and down.
Investors who understand this, buy below fair value, and sell above fair value will do very well over the long-term.
Yet, even if you’re aware of the roller coaster ride that you’re signing up for with equities (which are inherently risk assets), it can be very difficult not to lose track of reason and give in to emotional responses once volatility begins.
Due to human nature, very few individuals have the intestinal fortitude required to remain rational during trying times and the discipline to remain rational when others are exuberant. Therefore, the vast majority of retail investors fail to generate satisfactory returns.
That’s a somber statement, isn’t it?
I assume that the majority of readers here are retail investors. I certainly don’t mean to offend you. And, even more so, I definitely don’t want to discourage you.
Like I’ve said before, the stock market remains the best vehicle that I’m aware of when it comes to everyday individuals climbing the social ladder and/or reaching financial freedom.
And this is where I circle back around to dividend growth investing.
To me, the common pitfalls that most retail investors fall into (buying high and selling low) are created by paying far too much attention to short-term share price movements.
The market is a very volatile thing in the short-term. Watching the screen of your brokerage account and seeing the numbers shift from green to red can be dizzying. Paying too much attention to daily headlines about the latest market craze can be too. And frankly, I think all of this a waste of time.
To do well in the markets, you need to figure out a way to tune out all of the unnecessary noise.
Success in the market comes to investors, not traders. Instead of thinking about the shares that you buy as ticker symbols, I think investors are much better off thinking about shares as small parts of the high quality companies that you wish to own.
Actually, don’t even consider yourself to be an investor…but instead, a long-term partner in those businesses.
Once you adopt this mindset, it becomes much easier to maintain a long-term outlook, regardless of what commentators, talking heads in the media, and analysts are saying. It becomes easy to tame fear and greed and hold onto shares, regardless of which direction prices are heading.
Why? Because these prices are fairly inconsequential. They’re not what is going to allow you to reach that aforementioned financial freedom. No, that opportunity is created by the dividends each share produces.
By focusing on passive income, rather than share price movement, ignoring short-term volatility becomes possible. And, as the dividends you collect begin to roll in and compound, it becomes easier and easier to do so.
Sure, no equity dividend is ever guaranteed. Dividends can be cut at any time. Yet, when you partner with blue chip companies with strong sales, earnings, and cash flows, the dividends they pay aren’t just reliable, they’re predictable.
Because of this, I see no reason to fall prey to the hype surrounding the latest speculative growth stock, SPACs, cryptocurrencies, with little to no underlying fundamentals to support them. What’s more, it’s even easy for me to ignore the volatile trades involving more mature economically sensitive and cyclical stocks.
Simply put, I can’t imagine what life might be like if I was relying on market sentiment and share price movement to meet my financial goals. That must be incredibly stressful. Instead, I’d much rather sit back, pay attention to fundamentals, monitor dividend safety metrics, and collect a reliably increasing stream of passive income.
This focus on passive income allows me to plan out my financial future.
By removing so much of the noise that surrounds the market and really zooming in on what matters most – fundamentals – I can make rational decisions in any market environment.
In other words, I can stick to the basics of value investing: buying low and selling high…or better yet, not selling at all, but instead, holding over the long-term while compound interest fuels the exponential growth of my dividend income stream.
I speak with investors nearly every day and I know there are countless individuals out there who can’t sleep at night because of their financial situation.
I consider myself blessed to have come across the dividend growth investing strategy, because I’m able to rest easy knowing that my financial decisions are based upon sound and reasonable logic.
Also, when I lay my head down to rest each evening, I know that the companies I’ve partnered with are working for me, 24/7, generating cash that eventually trickles down to my pockets via dividend income.
In other words, this strategy allows me to make money while I sleep.
It doesn’t get any better than that, does it?
If you want to know more about the dividend growth strategy and begin your personal journey towards financial freedom, please check out The Intelligent Dividend Investor.
This newsletter product and actively managed portfolio is 100% focused on owning the best companies in the world and generating reliably increasing income.
Oh, and since inception, the Intelligent Dividend Investor portfolio has generated market-beating total returns, showing that with the right strategy, it’s certainly possible to have your cake and eat it, too (with regard to dividend income and strong capital gains).
Sound sleep and extra dessert? Sign me up!
That’s what I said years ago when I discovered the dividend growth investing strategy and I haven’t regretted that decision one bit in the years since.