Four Notable Dividend Increases From Last Week

As a dividend investor, my goal is build a portfolio that regularly grows dividend income. This ensures that my dividend income maintains its purchasing power, without me having to add new funds. It is little surprise that I regularly monitor the lists of dividend growth stocks for dividend increases every single week. This is a fun and easy way to observe how my investments are doing. Checking up on dividend increases also helps me in uncovering hidden dividend gems that I may have to add to my list for further research.

Over the past week, there were several notable dividend champions that rewarded their shareholders with a dividend increase. I have a stake in the first two, while the latter two are companies I have on my list for monitoring purposes. The companies include:

McCormick & Company (MKC) manufactures, markets, and distributes spices, seasoning mixes, condiments, and other flavorful products to the food industry worldwide. It operates through two segments, Consumer and Industrial. The company raised its quarterly dividend by 7.50% to 43 cents/share. This marked the 30th consecutive annual dividend increase for this dividend champion. The ten year dividend growth rate is 10.20%/year. The company is overvalued at 24.60 times expected earnings and yields 2%. I would be interested in adding to the stock on dips below 20 times earnings. Check my analysis of McCormick.

Three Dividend Seeds I Planted Last Week

I view each investment I make as a seed that I plant for the long-term. Some seeds could turn into a tree that would provide fruit (dividend income) for decades to come. My goal as an investor is to ensure that I plant those seeds in a systematic way that increases the odds of success. My definition of success is the ability to live off dividends when I decide to stop working.

In the past week, I managed to add to my positions in the following three companies:

Target Corporation (TGT) operates as a general merchandise retailer in the United States. Target is a dividend champion which has raised dividends for 48 years in a row. Over the past decade, the company has raised dividends by 20.30%/year.

The stock is selling at 15.20 times expected earnings for 2015 and yields 3.20%. Check my analysis of Target at Seeking Alpha.

The most interesting thing is that I sold two-thirds of my Target position in early 2015. Now I am able to get back in at lower prices. This happens very rarely, and is more of an exception rather than the norm.

Are you patient enough to become a successful dividend investor?

One of my largest holdings is McDonald’s (MCD). The company recently raised its quarterly dividend by 4.7% to 89 cents/share. McDonald's is a dividend champion which has raised its dividend each and every year since paying its first dividend in 1976. Given the yield of 3.20% and the dividend growth of 5% (and my estimated earnings growth of 5%/year), this sounds like a decent investment for slow and steady income and wealth accumulation. You might enjoy my latest analysis of McDonald's here.

Yet, a few months ago everyone had written McDonald’s off. Noone was supposedly eating there. Many investors sold out after earnings per share and the stock price went nowhere for 3 years. I didn’t sell however, because I know that most profits are made by patiently sitting on a holding, and doing as little as possible.

Replacing a dividend company sold is a very difficult endeavor. It requires that:

1) You correctly identify a company you own that is not going to do well, and will not provide good returns
2) You correctly identify a company that is going to do well and will return more than the company sold
3) The new company has to provide better results than the old company, and that is after accounting for taxes, commissions etc

There are several reasons below why I didn’t sell:

Relative Performance Comparisons are Useless for Dividend Investors

I started my site dedicated to dividend investing in January 2008. I had been able to accumulate some money for the first time in 2007, and had spent hundreds of hours teaching myself how to properly allocate it. The purpose for this site was to make myself do the work to form an opinion, and to share what I have learned and share my thoughts on investing.

Since the very beginning of the site, my goal has been to accumulate enough income producing assets. Once the income from those assets exceeds my expenses by a comfortable margin of safety, I would consider myself retired or financially independent ( you pick the correct word).

One of the lessons I have learned is that investing is part art, part science. A certain lesson can be very useful in some scenarios, but also very dangerous in others.

For example, if you have a winning investment strategy, you need to stick to it through thick and thin. An investor should not let temporary periods of bad performance influence you to jump ship. In my book, a strategy should only be evaluated based on whether it can help in reaching my goal of attaining financial independence.

On the other hand, you should also know when your strategy is no longer working or doesn’t make sense due to certain factors. If you stick to a strategy for too long, you will be unable to reach financial independence on time.

Is your head spinning yet?

Life after Financial Independence

In a previous article, I discussed that I will reach Financial Independence some time in 2018. After I reach the dividend crossover point, my dividend income will pay for expenses. Many assumed that I will just call it quits and live off the $1,500 - $2,000 in monthly dividend income that the portfolio will generate.

These assumptions are further away from the truth however.

Last year, I shared with you that I was running low on motivation on my quest towards financial independence. I was working at a job that was really nice to work at initially. After about an year or so however, I was put on a terrible project with impossible deadlines and management. After burning out quickly, I found a new opportunity.

I once worked at an organization just like that where I kept track of my time in 6 minute increments and worked 60 - 80 hours/week. Not a lot of fun, and a lot of backstabbing too. Though if you stayed for 10+ years, you could have made a lot of money and earned a decent pension too.

Then I moved to an organization where I worked 30 - 40 hours/week, and earned more income. The first organization taught me how valuable my time was. This lesson I never forget - allocating time is as important factor in success as allocating capital.

I enjoy my current position. I have ebbs and flows in the amount of work throughout the month, but I actually enjoy it. I could see myself doing that for several years after reaching financial independence.

Time in the market is your greatest ally in investing

The more I learn and experience about investing, the more convinced I become that doing nothing is the best strategy for long-term success in a portfolio.  I believe that time in the market is more important than timing the market. This is the conclusion I reach in an earlier article on the topic:

"The lesson to long-term investors is clear; it doesn't matter whether we are in a bull market or bear market. The goal is to dollar cost average each month in quality dividend growth stocks selling at attractive valuations, reinvest dividends, and hold patiently for the next 20 – 30 years. I cannot emphasize quality factor, since the quality companies are more likely to survive a deep recession unscathed, and continue paying and growing dividends, even during the hardest of times. "

When I was much less knowledgeable and experienced, I operated under the assumption that it is easy to just switch in and out of stocks, and thus outguess the markets. In reality, this was a foolish approach, since nobody can consistently go in and out of stocks. This is because it costs a lot in terms of taxes, commissions and time to sell a company and buy another one. The biggest cost of course is opportunity cost, since in the majority of scenarios I would have been better off, had I simply stayed put, and allocated my dividends in the best ideas at the time. Hence, the only time I have considered selling is if a dividend is cut, or a position becomes so overpriced or take such a weight in my portfolio, that it would be prudent to trim or eliminate it.

This belief has been further reinforced by a few examples that I have come across. I covered the first example a few months ago, when I discussed the performance of the original members of the S&P 500 from 1957. The second example is from a completely passive fund that was set up 78 years ago.

The Corporate Leaders Trust was created in 1935 with an equal number of common stock shares of the 30 leading U.S. companies at the time. The goal was to seek long term capital growth and income through investment generally in an equal number of shares of common stock of a fixed list of American blue chip corporations. After 78 years, it is currently invested in a total of 23 leading U.S. corporations. The trust cannot purchase new companies, so holdings have changed only due to spin-offs, dividend eliminations, or mergers since fund inception. The Fund is a passively managed grantor trust registered with the SEC as a unit investment trust. The fund was expected to be liquidated by 2015, but its life has since been extended through 2100.

The original 30 securities were:

The current 23 holdings are:

Source: Fund Website

There were only a few outright failures in the portfolio of the fund. However, what really helped results was the fact that the trust let winners run for as long as possible. As a dividend investor, I have learned that I should not sell, even if the stock I own is up over 1,000%. This is because it does not make sense to get rid of your winners, that will propel your portfolio forward, both in terms of capital appreciation and dividend growth. In a long-term portfolio that is held for generations, one could reasonably expect to have positions that result in mind-boggling returns over those decades.

You can view the historical changes in the portfolio holdings of the trust between 1935 and 1979 here:

You can view the changes in holdings between 1980 and 2015 below:

The changes are as a result of acquisitions, spin-offs, and dividend eliminations. When a company eliminates dividends or goes bankrupt, it is sold out.

A $10,000 investment in 1941 would be worth $18.40 million by the end of 2014, and generating annual dividend income of almost $400,000/year at a current yield of 2.23%. Source: Prospectus

The interesting fact is that since 1970, it has managed to outperform the S&P 500, while being completely passively managed. Source: Fund Website

This is a testament of the power of selecting the leading dividend paying blue chips of the time, and then patiently holding for generations. Investors in the trust ignored all the fads of the next 78 years, and did really well by investing in businesses that stood the test of time. A diverse portfolio of mature blue chip companies with enduring business models will generate loads of excess cash for their shareholders, which could then be reinvested into more shares at depressed values.

This is also a testament to the fact that the blue chip holdings are not expected to grow as rapidly as companies in hot new sectors, which is why those blue chips are perennially undervalued. As a result, dividends are reinvested into undervalued shares, which further turbocharges returns. When you have low expectations, valuations are low. However, if you manage to generate consistent earnings growth, this can result in very good investor returns. This is a superior strategy to the one where hot growth stocks are chased by unsuspecting investors who pay dearly for the chance to buy future growth, which rarely materialized to the extend expected. When you invest in a stock or a sector with inflated expectations, you pay a premium for it. If things do not go as expected, the valuation compression and the low increase in earnings serve as a double-whammy that prevents investors from realizing a gain.

If you really sit and think about it, long-term investing is the best ally of the individual dividend investor. It allows you to quietly compound your capital by focusing only on quality blue chip dividend paying companies that have enduring business models, while ignoring the everyday noise that tries to make you to do something, when in reality there is no need for you to act.

A 3% yield today might not sound like a lot today, but if you reinvest those dividends that grow at 6% – 7% annually for the next 30 – 40 – 50 years, the level of dividend income would be mind boggling. If you also look at that from the perspective of a company that grows earnings by 6% – 7%/year for that period of time, your wealth would be increasing a lot as well. The small yield today is the seed that will bring fruit to you and your family or charitable cause for decades to come. Do not waste it, but do the smart thing by investing it and watching it turn into a beautiful tree.

So to summarize, this fund proves that a diversified portfolio of blue chip companies that regularly pay dividends, and adapt to the ever changing economy is a great way to build and maintain wealth and income. It is a living proof that passive buy and hold dividend investing works for those who are patient and have a long-term mindset.

Full Disclosure:I have a position in T, BRK/B, CVX, XOM, GE, PG, UNP

Relevant Articles:

- Time in the market is more important than timing the market
- The Perfect Dividend Portfolio
- Where are the original Dividend Aristocrats now?
- Quality Dividend Stocks versus Growth Stocks
- What drives future investment returns?

Entering Wealth Preservation Mode

In my previous article, I discussed the concept of the dividend snowball as it applies to my dividend portfolio and dividend income. The powerful concept of the dividend snowball means that a portfolio generating $15,000 in annual dividend income could easily double dividend income to $30,000/year in a decade or less. This calculation assumes that no new capital is allocated to that dividend machine, and dividends were reinvested. Just for the sake of reference, I achieved the first $15,000 in annual dividend income in a little over eight years of savings and investing.

Now that I am getting very close to the dividend crossover point, and financial independence, it is time to make sure my financial house is in order. As the amount of money at stake increases, my desire for risk starts decreasing. This is why I have been thinking lately about including layers of protection around my nest egg that will protect it from future downside. Wealth preservation is as important as building wealth in the first place. If you have won the game ( or will have won it by the end of the decade), it is important to stop playing so hard and to make sure the downside is protected from risks.

Margin of Safety in Retirement Income: How to create a fool proof dividend machine for retirement

In a previous article titled, My Dividend Retirement Plan, I outlined the concept of the dividend crossover point. This happens when your dividend income exceeds expenses for the first time. The dream of every dividend investor is to achieve this point of financial independence. However, do not quit your day job yet. It might make more sense for income investors to postpone their retirement by a couple of years, simply to ensure an adequate margin of safety behind their dividend income.

In order to succeed, you need to layer your portfolio in a way that one black swan event is not going to derail your retirement plans. If you really want to fool-proof your plan, you should design your income strategy in a way that would allow you to retire, even if multiple torpedoes hit your portfolio. This is why I focus on building a diversified portfolio of dividend paying stocks, purchased at attractive valuations. I try to own at least 30 - 40 individual quality companies with competitive advantages, which are likely to increase earnings over time. In this article I am making assumptions that these qualitative factors are already accounted for.

In order to have a margin of safety in their dividend income, investors need to consistently generate an annual stream of distributions that exceeds their annual expenses by approximately 33% - 50%. This means that if your annual expenses are $30,000/year, your dividend income should be somewhere in the vicinity of $40,000 - $45,000 in order to have an adequate margin of safety. The factor is not set in stone, and could vary from as little as 1.20 times expenses all the way to two times expenses. This margin of safety is important, in order to protect investors against risks that they might have overlooked during the design stage of their dividend machine.

Building my dividend snowball to $30,000 in annual dividend income by 2024

One of my favorite books on investing is “The Snowball: Warren Buffett and the Business of Life” by Alice Schroeder. The book describes how Warren Buffett accumulated his fortune starting at a young age, up until early 2008 when he became one of the richest people on earth.

I like the concept of a snowball, where you start small, accumulate snowflakes as you start pushing it down the hill, and then you keep rolling the snowball until it turns huge. After that, the snowball grows even larger, without any additional input from you.

With dividend investing, you start small, and immediately get hooked the moment you receive the first dividend paycheck. The realization that you earned passive income without even lifting a finger has had a huge impact on the dividend investing community. The second realization that if you manage to put more money to work, and if you reinvest those dividends, you are going to grow that passive dividend income in the future. Let’s assume that I earn $20/hour from my job. The way I think about it is that for each $20 in dividend income I can receive today, I am essentially buying an hour of freedom from work. The following story from The Snowball, about Charlie Munger ( Warren Buffett's investing partner at Berkshire Hathaway) really resonated with me:

Charlie, as a very young lawyer, was probably getting $20 an hour. He thought to himself, ‘Who’s my most valuable client?’ And he decided it was himself. So he decided to sell himself an hour each day. He did it early in the morning, working on these construction projects and real estate deals. Everybody should do this, be the client, and then work for other people, too, and sell yourself an hour a day.

How early retirees can withdraw money from tax-deferred accounts such as 401 (k), IRA & HSA

One of the biggest mistakes I ever made was not maxing out my 401 (k), IRA and HSA accounts between 2007 and 2012. As a result, I ended up paying tens of thousands of dollars in income taxes and taxes on capital gains and dividends. Those are tens of thousands of dollars in taxes that could have built up my networth and passive dividend income. Instead I ended up handing those over to the IRS and my state. The opportunity cost of these money is in the hundreds of thousands if not the millions over the next 30 - 40 - 50 years.

The reason why I never maxed those out is because I didn’t know a lot about them. I also prided myself with my success that I was paying a lot in taxes. When I was doing my 2012 tax return however, I was sick that my total tax liability exceeded the amount I paid on housing and food. In fact, the amount I paid in taxes was equivalent to what I can live on in retirement. I saw that a fellow blogger from the site Budgets Are Sexy had written about maxing out his SEP IRA and Roth IRA’s, thus saving tens of thousands of dollars in taxes just for one year. So I opened a SEP IRA and maxed it out, saving 30 cents in taxes from every dollar I contributed to. Here was I researching companies, competitive advantages, earnings and valuations, yet I had overlooked the simple power of tax-deferral and tax-deferred compounding of capital. As I kept researching, I I found the sites of Mad Fientist and Go Curry Cracker, which opened my eyes on the benefits of tax deferred accounts. These investors had managed to retire early by taking advantage of the tax code, and then were paying zero dollars in taxes during their early retirement. Another one I thoroughly enjoy is Justin from Root of Good, who retired at the tender age of 33 and paid pretty much zero in taxes.

My biggest misconception was the fact that I thought that the money is locked until the age of 59 and a half years, and that I cannot touch the money. This was wrong. I also see this misconception has deep roots in many dividend investors I have talked to. These investors mistakenly believe that you cannot withdraw money from retirement accounts when you are aiming for early retirement in your 30s or 40s or 50s. As a result of this misconception, these dividend investors will end up hundreds of thousands of dollars poorer over their lifetimes. This is the reason why I am writing this article. Ever since I had my awakening moment in 2013, I have tried to educate investors. I have been unsuccessful for some, but I will continue fighting.