Why Paying Attention to Dividends will Make You a Better Investor

Investing can be complicated. There are as many investment strategies as there are investors. And, it can be incredibly hard to tell the difference between good advice and a good sales pitch.

According to a GoBankingRates.com survey, the number 1 reason people aren’t investing is that they don’t have the money. As a result, a lot of financial advice focuses on wage stagnation, budgeting, and other topics designed to help people cross that hurdle.

But, what about the other reasons?

There is a huge group of people who have the money to invest, but they don’t. Why not? According to that same survey, 45% of people don’t invest for some reason other than not having the money.

You read that right. Nearly half of people who don’t invest are on the sidelines for some reason even though they have the money available. Why?

Three major reasons center around fear and uncertainty. Over half of the people who have the money to invest but don’t said they avoid investing for one of three reasons:

  1. They don’t trust the stock market;
  2. They don’t know how to invest; or,
  3. They’re afraid to lose money.

So, what can you do to take the fear and uncertainty out of investing?

For me, the light bulb came on when I decided to pay close attention to how my investments produce income. I separate share price fluctuations from dividends and see how each impacts my performance. And, that changed everything.


An Example

For the rest of this article, I’m going to use a hypothetical portfolio with $100,000 that is split 50% between stocks and bonds. The stocks will be an S&P 500 index fund (here’s an article on why the S&P makes a good investment). The bonds will be a high-income bond fund (here’s an article on why Fidelity’s High Income Fund SPHIX is a nice choice).

This is just an example, not an investment recommendation. Check out this article to learn how to build a diversified portfolio.

S&P 500

In the 20 years between 2000 and the end of 2019, the S&P 500 averaged 7.65% (including dividends, according to Yahoo Finance & Robert Shiller). However, that growth was a very rocky road. The S&P had negative returns in 6 of the last 20 years! The worst was 2008, when nearly 40% of the S&P was wiped out.

So, in this hypothetical portfolio, the $50k in stocks is going to jump around. From year-to-year it is going to soar sky-high, and it’s going to fall nearly in half. But, over the long-term it is likely going to grow.

The S&P also pays dividends. As an owner in the 500 largest and most successful companies in the US, you are entitled to a cut of the profits. When those companies decide to distribute a dividend, you get paid. Right now the dividend yield on the S&P 500 is about 2%.

High Yield Bonds

The bonds in this portfolio will go up and down too, but not nearly as much. Most of the performance of these bonds will come from monthly dividend payments. On the last day of every single month, you will get paid based on how many shares you owned that month.

Between 2008 and 2018 SPHIX has paid between $0.46 and $0.64 per share in total distributions annually. I only focus on 2008-2018 because interest rates have been incredibly low, and I keep hearing that investors can’t get high yields anymore. Well, the share price of SPHIX is currently about $9. If you bought $50,000 worth of shares, you’d get about 5,600 shares, and those shares would pay between $2,600 and $3,600 in dividends every single year. That’s a yield between 5.2% and 7.2%!

So, now we have a portfolio with $50k in the S&P, which jumps up and down in value, and pays about 2%. And, we have $50k in bonds that don’t move around in value as much, and pay about 5%.

Tracking the share price separately from dividends with a portfolio like this, three big things happen:

  1. Dividends make retirement planning much more straightforward;
  2. Dividends take the stress out of volatility; and,
  3. Dividends keep you motivated to continue investing.

Dividends Make Retirement Planning Much More Straightforward

The first thing that happens when you start paying attention to your dividends is that all of the mystery of retirement planning disappears. If you had built this portfolio in early January 2019, then you would have received dividends of about 2% of the stock ($50k x 2% = $1,000), and about 5% of the bonds ($50k x 5% = $2,500).

Most people look at their investment statement and see that the value has increased or decreased and are either happy or angry with the results.

Instead, I look at the dividends and see that the $100k in this portfolio created about $3,500 of new money. That does two things:

First, before retirement I can use that $3,500 to buy more shares… which means that next year I will get even more dividends.

Second, I can start to plan out what my retirement income will look like and how long it will take me to have enough income to replace my job. Let’s say you want to make $50,000 in retirement. Well, you’ve already got $3,500, so now you just need to go find another $46,500!

Using this approach, there will come a point when you look at your year-end portfolio summary and see that there is enough income being produced by your money to live on for the rest of your life. At that point, you will have achieved financial independence.

At that point, if you continue to work, it will be because you want to. Not because you need to.


Dividends Take The Stress Out of Volatility

The second thing that happens when you separate dividends from share-price fluctuations is that you become much more tolerant of jumps and drops in portfolio value.

The hypothetical portfolio with $100k will produce about $3,500 in dividends. That will happen when the economy is booming (dividends might be a bit higher), and that will happen when the economy falls into recession (dividends might be a bit lower).

You will never lose dividends. You will always receive dividends.

And, because you are using dividends to buy more shares this strategy allows you to take advantage of market downturns. You can use that $3,500 to buy new shares which are discounted! For example, in 2008 when the S&P lost 40% of its value, your $3,500 would have bought a ton more shares than it would now! And, because dividends are paid on a per-share basis, that means an even bigger raise.

That is not to say that I look forward to market corrections or recessions. But, it is good to have a strategy to profit from all market conditions. Because if you are hoping for a certain result, that is called gambling, not investing. For more, check out this article on how to profit from all market conditions.


Dividends Keep You Motivated to Continue Investing

The third and final thing that happens when you separate dividends from share-price fluctuations is that you see immediate results from adding money to your portfolio.

If you have this hypothetical portfolio and you are just watching overall performance, then adding $10k is not very exciting. Before you invest an additional $10k, you have $100k. After you add the $10k, you have $110k. It doesn’t feel like much changed, and the increase was totally a result of your effort, not performance of the investment.

But, something super cool happened. You now have more shares, so next year instead of getting paid $3,500, you’re going to get paid about $3,850. You just got a raise! And, you will be able to see that increase reflected in your dividend payment in the very first month after you make the investment.

By taking the mystery out of investing, you don’t feel like you’re just pouring money into some black hole and hoping it turns out okay. You are taking control of your money. And, you are able to see exactly how your money creates an income, even before your retire.


Final Thoughts

Investing is fairly complex. It is a bit like learning a new language.

But, it is not rocket science. It is not so complicated that you can’t wrap your head around its concepts.

The most important advice I can give about investing is to make sure you fully understand what you are getting into before you invest. If the product is too complicated or you can’t seem to grasp what it is that you are buying, then don’t buy.

If your investment person feels like a salesperson, then they probably are. Find one that is happy to spend the time to help you understand what you are getting into, or do it yourself.

You can also check out my book. Nearly half of the content is focused on how to build a portfolio and get paid for having money.


I hope this has been helpful! I welcome your comments with your thoughts and questions. And, don’t forget to subscribe to the newsletter to get notified whenever a new article is posted.

Join the conversation

This site uses Akismet to reduce spam. Learn how your comment data is processed.