The beauty of passive income sources
Investing in dividend-paying stocks is one of the easiest and most rewarding ways to establish an ever-increasing and reliable passive income stream.
In contrast to active income (from a job), passive income is not (directly) linked to time. As a shareholder of The Coca-Cola Company, for instance, you are getting paid each quarter in form of dividends. You do not have to show up at the corporate headquarter, you don’t have to work and spend your time with that company. You just hold your shares and get paid. That’s it. Dividend investor income is fully passive. In that same category also belongs rental income.
Having passive income streams puts you in an incredibly strong position. It provides you with flexibility and stability in your life. You are in a strong, enviable situation to leave any negotiation table as a winner.
Relying solely on one active income stream – aka job – is risky. Having – in addition to a job – two or three passive income streams catapults you in a much more comfortable position e.g. when corporate positions are being made redundant (as have been in the millions amid the COVID-19 pandemic).
The great advantages of passive income are the following aspects:
- it not only provides you with extra income
- but it also let’s you diversify your income mix and
- without having to spend additional time to receive these cash flow, income generation gets scalable.
- Passive income let’s you benefit of the compound effect,
- gives you an incentive to save and invest money
- which as a whole process leads to a great learning effect.
In short, passive income stands at the core of a positive virtuous circle that – once put into motion – will work tirelessly in your favor.
The only thing you have to do is being consistent, persistent, and motivated, as it takes some initial effort and quite some time to establish reliable passive income streams. So, the sooner you start, the better.
With that being said, let’s come to my favorite passive income source.
Which stocks build the backbone of your dividend portfolio?
If you take the SavyFox stock portfolio for example with its roughly thirty positions, consisting of
- dividend paying shareholdings and
- tech growth stocks,
the purpose is to generate over time substantial book gains plus passive income in form of shareholder distributions from the dividend-paying stocks.
Tech Growth Companies such as Alphabet, Amazon, Facebook, and Adobe currently don’t pay any dividends. The focus of these businesses is to invest heavily in infrastructure and growth initiatives. But in the near future, in particular, the tech behemoths, literally swimming in cash, will make shareholder distributions.
As a Dividend Growth Investor, you want to have strong growth stocks in your investment portfolio that will make attractive future dividend payers. That aspect seems to be often neglected, but you need a long-term horizon. Just look at Apple, Microsoft, and NVIDIA for instance. These tech giants grow at a spectacular rate and at the same time reward their shareholders with dividends plus share repurchase programs.
And besides the future dividend payers, you want to put rock-solid dividend payers at the core of your investment portfolio. Companies like PepsiCo, The Coca Cola Company, Hershey, Nestlé, Fresenius, L’Oreal, Mc Donalds, etc. These are stocks that built generations of investors a fortune, these are long-term positions rewarding the patient shareholder for doing nothing, for just sitting on his or her stock positions.
It’s these companies you want to see as the backbone of your investment portfolio. Businesses that play in the exquisite league of the prestigious Dividend Aristocrats, consisting of a group of businesses that managed to increase their shareholder payouts for at least 25 consecutive years.
Choosing a good mix of dividend paying stocks
So, while most investment portfolios of Dividend Growth Investors put Dividend Aristocrats at the core, it makes sense to add some Dividend Challengers as well. That term is being used for companies with at least five to nine years of consecutive dividend growth rates. Microsoft and Apple for instance are Dividend Challengers. Microsoft hiked its payout by 10 % recently and Apple by 7 %. These businesses show robust growth and are very dynamic. In fact, chances are good, that these will be future Dividend Aristocrats decades from now.
The Coca-Cola Company and Mc Donalds in contrast showed slowing dividend growth, hiking their payouts only by 2.4 % and 3.2 %. That’s not rare to be seen, maturing businesses tend to slow their dividend hikes. But make no mistake, holding such a position can reward you handsomely over time. And by reinvesting the dividends into the same stock position, you are putting the compound effect literally on steroids.
What about high-yield dividend stocks?
High yield in this context refers to the dividends received in relation (as a percentage) to the stock price you pay. High yield stocks typically are 4 % and above. You see such dividend yields with oil supermajors, like Chevron, British Petroleum (BP), Royal Dutch Shell (RDS), and its French peer Total.
Well, in 2020, these giants had a dividend yield of roughly 8 %, but unfortunately, in the case of RDS and BP, this was just on paper as they slashed dramatically their shareholder distributions.
Now, here come two different philosophies to play: while some Dividend Growth Investor would cut or eliminate their positions because a business lowered its payout, I wouldn’t advocate that. First, it’s not rare that the timing of a dividend cut cannot be anticipated in advance, and secondly, the market reaction is quite often exaggerated, punishing stocks of these businesses heavily. Selling immediately after a dividend cut often means selling at the bottom. I have seen stocks of many businesses recover handsomely after a dividend cut, as more cash remained in the business and the fundamentals improved. Just look at the stock price of The Walt Disney Company for instance or French luxury giant LVMH. Both businesses slashed or even eliminated their dividend payouts in 2020 amid the global lockdowns. Both businesses, The Walt Disney Company as well as LVMH emerged as big winners out of the pandemic.
In my view, cyclical stocks such as oil companies, etc. have their place in a diversified portfolio. But take care to limit the exposure to each sector.
Diversify over industries, countries, and companies. For instance, I would rather have one position in French oil giant Total and British Petroleum than just in one of these companies. The same of course with tech companies. For instance, I prefer having a position in Amazon as well as Shopify, Alibaba, Microsoft, etc. than being concentrated on just a very few positions.
When to buy stocks?
History shows, that a well-diversified investment portfolio with stocks of high-quality businesses has been almost certain to grow steadily over time. Empirical data is just overwhelming, showing how superior Time in the Market is and that the optimistic Buy and Holding Investors are rewarded handsomely over time.
So, putting a lump sum to work by investing in shares of strong businesses makes a lot of sense.
However, most of the time an investment portfolio is built up slowly by investing savings regularly, each month. These amounts add up and can build huge wealth over time. The process of regularly investing a certain amount into stocks or Exchange Traded Funds (ETFs) is referred to as Dollar Cost Averaging. It’s a great way to keep constantly investing, no matter what the stock market does. On average, over time, you get an attractive price for your investment positions.
So, coming back to the question “when to buy stocks?“, the answer is simple:
- whenever you have the money
- and you don’t need that cash for at least ten years and
- whenever you are prepared to get into a position of a high quality business over the medium and long run.
But wait, why stocks instead of an ETF?
Exchange Traded Funds (ETFs) are funds that track an index such as the Standard & Poors and are sold and bought on a stock exchange. ETF’s are a very clever, cost-efficient way to build a diversified portfolio.
JLCollins, author of the book “The Simple Path to Wealth” has a fantastic investment series on his website I would highly recommend. One of the messages is that for most investors, ETFs really is the best way to take exposure to corporates. Empirical data is just overwhelming. Invest regularly into a good, low fee ETF and over time you will be rewarded handsomely. Actively managed mutual funds are more expensive which most of the time is not justified by superior returns. In fact, most actively managed funds underperform ETFs.
As for me, I prefer investing directly into the stock of businesses I like and diversify my investment portfolio. I hold my positions over the long haul. That is for a few reasons: I see myself as an “investing partner” of these companies and I found that the learning effect is just huge by thinking like that. But of course, it takes time, to analyze businesses.
Over the long run, as a stock portfolio gets more and more diversified, the performance should more or less equal the one of a major ETF that tracks the S&P for instance.
So, how about these monthly dividend payments?
With a diversified stock portfolio, it is very simple to receive dividend income every month. Some businesses – in particular from the US – make their shareholder payments quarterly. European companies pay out dividends once a year. But there can be differences. For instance, Anglo-Dutch oil giant RDS makes its distributions each quarter as does French peer Total. French luxury giant LVMH twice a year. But the bulk of European businesses make annual dividend payments.
Now let’s look at the SavyFox dividend contributors. For each month of the year, there is at least one business that pays out shareholder distributions:
As the schedule shows, each month there is fresh cash flowing in from strong businesses, ready to be re-invested into the portfolio, making that compounding machine stronger and stronger over time.
You are responsible for your own investment and financial decisions. This article is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.