In my quest to early retirement, one of the questions I have asked myself is what would be the best retirement investments to make to both reach early retirement and to be able to keep my financial independence forever?
Since I want to retire young (at or near 45 years old) I had to choose an investing method that would combine several great qualities at the same time. First, my “best retirement investments” would need to provide me with a good protection of my capital and capital growth at the same time. Second, it would need to provide me with steady income. Third, the income would need to at least keep up with inflation and even better, it should grow.
With these criteria in mind, I have searched in books and around me to finally decide to pick a method that suits me well. It is called “dividend growth investing“. This method, to my own belief, combines all of these qualities at the same time.
Dividend growth investing has been a revelation to me. Truly! I firmly believe it is one of the best way to both achieve financial success and financial independence. I even think it is a better approach than real estate investing because it doesn’t require a huge amount of capital to start and because all of my money won’t be tied into one single investment.
Remember the saying : “Never put all your eggs in the same basket!”
I don’t think I will invest in real estate anyways… I don’t like it. Dealing with tenants is too much of a hassle and here in Quebec, laws are a little too much in the tenants favor. It is socially good, but from an investor’s point of view, they have put a lot of barriers. But I do recognize and think that real estate can provide diversification to a seasoned investor and that it can offer a great lever to become rich fast if done properly.
But what is dividend growth investing anyway?
Dividend growth investing is an income investing strategy in which an investor chooses to invest only in dividend paying stocks. But he also chooses to only pick stocks of companies who have the policy to not only pay a dividend every quarter to its shareholders but who also has the policy to raise it every year at a rate higher than inflation.
Yes, these companies exist! And there are a lot! Think about Exxon, Wal Mart, McDonald’s or Johnson & Johnson just to name a few. These dividend paying companies have paid and raised their dividends every year for more than 25 straight years at a rate far above inflation! You can use my free screener if you’d like to see what kind of companies could fit your criteria.
Relative protection through dividends and diversification
Nothing is free in this world. And a 100% protection does not exist. Treasury bonds offer almost a 100% protection but there is still a risk to face… the government could default. It has happened to some governments in the past and it will happen again. Will it happen in the US or Canada? Who knows?! Anyways, security comes at a price and this price is the interest I’m going to get.
A 5 years treasury bond currently offers a meager 1,25%, which does not even cover real inflation. Real inflation? I’m talking here about the inflation on housing, food and energy which is in my own belief far higher than the official inflation they publish. This is on what most of my money and probably most of your money is spent anyways.
With a 1,25% yield, my money would be losing field to inflation.
Stocks offer a yield usually not that much higher than treasury bonds at first. But, that does not mean that stocks are bonds. If there is a market crash or if the company starts to face difficulties like Mattel then my capital is at risk and losses can be great.
On the contrary, a treasury bond will keep its value while your stock can increase or decrease in value.
The dividend growth investing strategy offers some income protection through two ways. First, through diversification. I can own stocks of many companies, some will outperform, some will underperform, most will do okay. Overall, through diversification, a portfolio can get some stability. Also, most dividend growth stocks have a low beta, which means that they fluctuate less then the market in its whole.
Second, the dividend itself acts like a security net. Why? Because most people who buy dividend paying stocks are shareholders for the same reasons I am. They want the dividend and the dividend raise. This steady income can be cut anytime but I wouldn’t want to be the CEO who would cut Wal Mart’s dividend as all the shareholders would be very mad at me.
A dividend growth policy acts as a security net because of the shareholder’s pressure but also because as soon as the company maintains or even raise the dividend, share price can resist more to downward pressure than a regular stock and if the dividend is raised then the share price should eventually go up too as the market will rebalance things out and the stock will be worth more to income investors.
Finally, to protect my income and capital I also have to keep something very important in mind : I’m investing for the long term! A long-term investor who would forget that could become his worse enemy and could sell stocks at the wrong time like most people do. Do you remember the saying buy low and sell high. While it is obvious, most self-directed investors do exactly the opposite… Weird huh?!
When the price of a share goes down, you still own the share and this is a part ownership of a company, not a losing lottery ticket. As long as you don’t sell, what have you lost? This does not mean that I have to sink with the ship if even the captain jumped out but this means that I can just wait if the fundamentals remain strong. Eventually, the tide will go up again.
Stocks like Wal Mart and McDonald’s or 3M have paid and raised their dividends even during the 1987 crash and even during the 2008 crisis. Strong companies make money when it rains, when it snows and even when the market is down. They see crashes as opportunities to strengthen even more their position while their competitors strive and suffer.
Income protection and growth
There are two sure things in life : tax and death. I’m sure you heard that at least once. I would add to that inflation. Inflation is in fact the worst enemy of the investor who does not understand its evil power!
Let’s say we have a 3% rate of inflation. This means that 1000$ on january first is worth 970$ on december 31st. And this will compound… You’ll still have 1000$ in your account at the end of the year but since price went up, you’ll only be able to buy 970$ worth of january first merchandise.
It doesn’t seem that bad but remember how much was costing gas, houses, electricity, phone bills or food 20 years ago?! If your income does not grow at least as fast as inflation, you will lose field and eventually become poor.
For example, if you put 1000$ in a treasure chest, bury it in your garden and open it 20 years from now, it will still contain 1000$ but you’ll only be able to buy 553$ worth of stock with it given a constant annual inflation rate of 3%. If you would wait 50 years before opening the chest, it would only be worth 228$…
Since I want to retire young, it is very important to consider inflation in the equation because, if I would retire over 30,000$ per year at 45 years old and if my income does not get a protection from inflation, at 75 years old, it would only be worth 12,360$…
Dividend growth investing can shield me from that because most of these companies just pass inflation to their customers when they sell products. As such, these companies can keep up with inflation and reward their shareholders!
Lowell Miller has written a book in great details about the benefits of dividend growth investing. He called this book “The single best investment”. While pretentious in a way, this title seems to reflect reality to me.
Dividend growth investing is not a get-rich-quick scheme for sure. It is easy to implement but hard to follow and it will take years to pay off. Every month I have to tighten my belt in order to reach my dream and invest my hard-earned money into my future. I do it because I know that the snowball will grow bigger year after year. Eventually, it will be big enough to let me consider quitting my day job!
If I would have to choose again the best retirement investments to make, I would choose dividend growth investing again. My only regret is not to have understood a while ago the power of the strategy!
Good luck with your investments!
Full disclaimer : long XOM, WMT, JNJ, MCD
Image courtesy of Stuart Miles / FreeDigitalPhotos.net