For a lot of reasons, dividend growth investing is becoming more and more popular every day. The historically low interest rate on fixed income is perhaps one important reason for this trend. However, an equally important, and perhaps even the most important reason, might just be that investors are better informed on the dividend growth strategy than ever before.
On the other hand, there seems to be a side effect to the better medicine that dividend growth investing offers. As dividend growth investing has become more popular, there have been many proponents gleefully willing to share their enthusiasm and commitment to the benefits of dividend growth investing for their retirement portfolios.
This has simultaneously created the equivalent of a negative feedback loop against dividend growth investing. Sometimes dividend growth investors appear to come off as smug, and this irritates certain people. Personally, I don’t believe they are as arrogant, as they are enthusiastic disciples of the incontrovertible logic supporting dividend growth investing as a prudent and viable strategy.
However, as it often is with controversy regarding investment strategies, much of the consternations are rooted in biases rather than facts. Furthermore, I believe there is also a strong element of prejudice against all things equities built into many of the arguments against dividend growth stock investing. Investors remembering the enormous trauma of falling stock prices during the Great Recession of 2008 are quick to paint all equities with the same high-risk brush.
Moreover, the stress from watching their retirement portfolios depreciate in value, as stock prices fell, caused many to take unnecessary losses. The Great Recession, and all the media blitz that surrounded it, panicked people into selling perfectly good stocks at the bottom of the market. For those whose investment objectives were total return in order to accommodate liquidating part of their portfolios under the so-called 4% rule, this behavior was somewhat rational. Here is a link to a recent Wall Street Journal article that elaborates more on the 4% rule:
However, dividend growth investors, as I will elaborate more on later, who are mainly focused on the income component of their portfolios, were spared this financially devastating fate. But for now, let me state that what differentiates the dividend growth investor from the total return investor most, is their focus on income over price volatility. The point is that even though the prices of their dividend growth stocks were falling during the great recession of 2008, for the most part, their incomes continued to grow. Dividends usually don’t fall with stock prices, they are usually only in jeopardy if earnings are simultaneously falling.
Most of the arguments that I have seen being placed against dividend growth investing as a safe and reliable investment strategy for retirement, are caused from a deeply rooted level of trauma caused by these previously mentioned massive 2008 price drops. The rhetoric usually goes something like; quality dividend paying stocks did not protect investors from the enormous losses to their portfolio values caused by the Great Recession of 2008. Dividend stocks, they argue, fell just as much and alongside non-dividend paying stocks.
The mistake behind this logic is in not understanding that all stock price drops are not the same. For example, if the business behind the stock remains strong, i.e. earnings continue to grow and advance or at least remain profitable, a falling stock price will often represent an opportunity. However, if stock prices are falling in concert with an unending deterioration of business fundamentals, then the stock price collapse may be generating a permanent impairment of capital. Understanding these distinctions is critical with implementing a successful stock investing strategy. I will provide examples later in the article.
Why Accomplished Dividend Growth Investors Can Ignore Stock Price Volatility
First of all, let me start this section by saying that it is not true that dividend growth investors do not care at all about capital appreciation (Total Return). In truth, they care very much, and who doesn’t enjoy seeing the value of their stock holdings appreciate over time. However, the competent dividend growth investor attempts to build a dividend paying portfolio that will support their retirement needs without ever having to harvest any of their principal. Therefore, as long as their income is not affected by price volatility, they can calmly and intelligently ignore volatile market actions. This is a great and powerful advantage.
Furthermore, the accomplished dividend growth investor also attempts to position their dividend paying portfolio in stocks that can provide them an increasing dividend each year. Consequently, the income component of their dividend paying stocks offers a built-in inflation hedge. With a well-designed dividend growth stock portfolio the retiree is no longer subjugated to living on a fixed income. Dividend growth stocks with a long legacy of increasing their dividend every year offer the retiree the benefit of a raise in pay each year.
With Quality Dividend Growth Stocks, Dividend Income Is Stable But Prices Are Not
Most investors are fixated on, and some even obsessed, with the price movements of their common stock holdings. If the price of a stock they buy drops after they buy it, it is immediately categorized as a dog, and vice versa. The problem with this line of thinking is that a price rise, or drop, can actually be quite irrational, and therefore misleading to the extent that it can cause the opposite reaction to what it should. In other words, it often incites people to buy when they should be selling and sell when they should be buying.
Consequently, investors are often conned into making the classic mistake of buying high and selling low. Peter Lynch tried to point out the error in this line of thinking when he said:
“Just because you buy a stock and it goes up does not mean you are right. Just because you buy a stock and it goes down does not mean you are wrong.” Peter Lynch ‘One Up On Wall Street’
I believe that investors in common stocks, dividend paying or not, need to recognize that price volatility is a fact of investing life, and cannot be avoided. The stock market is an auction, where people are continuously buying and selling stocks. Therefore, like any auction, prices can be quite volatile and often