Three Powerful Advantages of Dividend Strategies

Here are three powerful advantages of dividend-based strategies.

1) Dividends continue indefinitely.
2) Dividends isolate you from price fluctuations.
3) Dividend-based strategies have a gentle failure mechanism.

Dividends continue indefinitely

Making sure that dividend income will continue is straightforward.

Dividends come out of earnings. As long as earnings, averaged over several years, are healthy, dividends are secure. Many people are more comfortable evaluating the quality of earnings than earnings growth and other factors. Diversification makes a lot of sense when you focus on dividend income.

Dividends isolate you from price fluctuations

This allows you to sleep at night. With dividend-based strategies, you never sell any shares. You purchase income streams. Prices can fall in half, but your dividend income will remain secure as long as earnings remain strong. It might even grow.

Dividend-based strategies feature a gentle failure mechanism

This is critical for retirees.

With conventional strategies, which include selling shares, the danger is selling too many shares when prices are low. This is dollar cost averaging acting in reverse, lowering the average price of shares sold. It is hard to know when to adjust withdrawals. It is hard to know how much to adjust withdrawals.

Dividend income streams are different.

Even though dividend income generally keeps up with inflation and usually surpasses it, there have been instances when dividends have fallen behind. This happened during the stagflation that began in the 1960s. Nominal dividend income continued to grow, just not as fast as inflation. Dividend investors lost ground. So did everyone else.

Year to year adjustments were gentle and natural. The absolute worst case was limited to 20%, which is comparable to reducing a withdrawal rate from 5% to 4%. This was followed by a full recovery.

If you go back to the years of the Great Depression, you can find worse dividend cuts. Back then, companies would pay much more than they should have. Sometimes, the S&P500 payout ratio exceeded 100%. Companies are much more conservative today. By historical standards, today’s quality of earnings for the S&P500 is very high. This is representative of the stock market as a whole.

Have fun.

John Walter Russell
May 7, 2006