By Josh Arnold of Sure Dividend
The world of investing, with its vast, complex network of assets, exchanges, participants, and relevant factors, can seem overwhelming. After all, billions of dollars are spent every year around the globe by firms trying to create or maintain an edge they may have on the rest of the market, which can form the basis for incredible wealth creation.
However, individual investors cannot – and should not – attempt to compete with these firms. Rather, individuals looking to build wealth over time can follow some fairly simple principles that ignores all the noise, and build a strong nest egg that will be available when needed.
Whether the goal is to pay for a child’s education, buy a house, or retire, we believe the path to success in investing is the same.
In this article, we’ll discuss why it is important to maintain a long-term focus, and in doing so, how to select the best dividend stocks to help an investor reach their ultimate goal.
Being in it for the long haul
For any investor, the goal is to create wealth over time. If that’s not the goal, then investing is not the right use of one’s capital. While everyone agrees on the ultimate goal being to create wealth, that’s where the similarities end in terms of the various strategies to do so.
Many investors try to create unbelievably massive returns in short order, which can only be done by taking on undue risk. By definition, these risky investments have a very low chance of working, which means that this sort of strategy is doomed to fail for the vast majority of investors that undertake them.
This includes using leverage, using options, or simply buying low-priced stocks that may have a declining business, bankruptcy risk, or other fundamental issue.
Rather than try to get rich quickly, we believe the best strategy is to build wealth gradually over time, understanding there is no “get rich quick” scheme in investing that actually works. After all, if there were, wouldn’t everyone do it?
The goal of avoiding these extremely risky investments is, of course, to boost the return profile of one’s portfolio. The best way to boost the return profile is, first and foremost, don’t lose any money. If that can be achieved, the returns can take care of themselves.
That sounds simple enough, but how does one do that? We believe the best way to setup for success is to find strong dividend stocks and buy and hold them for a period of years or decades.
This has been proven time and again as a safer strategy than most in the stock market, and importantly, has a history of compounding wealth over the long-term.
Some of the world’s most famous – and most successful – investors have made their fortunes by adhering to this simple principle, and we believe that even beginner investors can easily follow this strategy on the path to compounding their wealth.
Of course, this strategy requires discipline not to panic and sell during tough times, and the patience to wait for the strategy to work. Unsuccessful investors tend to lack both discipline and patience, so these are the traits that a beginner investor should focus on building. With discipline and patience come the rewards of compounding wealth long-term.
The reason we favor long-term investing is that it smooths out the inherent noise of daily price action in the stock market. This has several benefits, not least of which is the ability for the investor to “tune out” the ups and downs that naturally occur in financial markets.
If one’s focus is on 10 or 20 years from now, today’s price really doesn’t matter. Long-term investing, therefore, helps the investor remain focused on the goal, not every tick up or down in the portfolio’s value.
In addition, stocks tend to rise over time as earnings increase. By selecting high-quality dividend stocks, and then holding them for long periods, the odds of success are exponentially increased. Even when we account for harsh recessionary environments, such as the dot-com crash and the financial crisis of 2008, dividend stocks perform extremely well over long periods.
However, periods like the dot-com crash and financial crisis highlight how important a long-term focus really is, because losing sight of the goal during times like these can cause the investor to sell at the worst possible time. That’s why we believe in selecting high-quality names, and ignoring the noise of daily price action.
In other words, long-term investing is a bet on the US economy performing well over time, which is a bet that has worked over and over again throughout history. Periods of weakness are inevitable, but that’s why the long-term focus is so critical to making compounding work for the individual investor.
Having a long-term orientation has other benefits as well. If we think of a day trader, which is someone that is in front of their screen all day, making dozens of trades (or more) throughout the day, we see the opposite of someone with a long-term mindset.
Day traders attempt – mostly unsuccessfully – to time various securities for small but quick gains. This is the antithesis of what we believe the best investing strategy is, so it provides useful context for what to avoid, and why.
Day traders, must spend enormous amounts of time scanning for opportunities, assessing the risk and reward of those opportunities, and acting upon them. That is time – generally hours every market day – sitting in front of the screen and working. In addition, constantly churning through innumerable trades means the investor is subject to very high transaction fees, and of course, taxes.
Every trade an investor makes, even with a “no-fee” broker, is subject to transaction and exchange fees. That means that each time the trader hits the buy or sell button, it costs the trader money.
In addition, even if the trader manages to be profitable with this strategy, gains are subject to short-term capital gains taxes, which are quite high, much higher than taxes on dividends and long-term capital gains.
In other words, by looking at what a person with an extremely short-term mindset is dealing with, we can easily make the case for why long-term investing is the better path to go.
Long-term dividend investing does not require the investor to constantly watch markets for hours a day, does not generate onerous fees or short-term capital gains, and instead offers the better of all of those factors to the individual. We know which path we prefer given those scenarios.
So what is the appropriate amount of time spent on investing for the individual? The answer depends on many factors, but in short, as little as possible. That’s the beauty of investing in high-quality stocks for the long-term; it doesn’t require anything but the bare minimum of effort over time.
We believe that investors with a long-term mindset can review their investments quarterly, or even just twice a year, and be highly successful. Contrast that with the hours per day a short-term trader spends and the benefits of time freed up alone are enormous. That gives the long-term investor hours per day back into their life they can use to do something else.
The tax issue is one we believe warrants some discussion as well, because long-term capital gains taxes are owed only when the investor sells. Whereas the short-term trader must pay taxes on gains in the year they’re made, if one owns a stock for 20 years, taxes are due only at the end of the 20th year.
That means that for that entire period, the entire investment is compounding wealth for the individual. That includes receiving dividends on the investment, as well as capital gains. It’s a powerful tool in the arsenal of the beginner investor, and we believe it is a far superior way to compound wealth over time.
Now, let’s turn our attention to the case for selecting great dividend stocks.
Achieving success through quality dividend stocks
Once the individual investor agrees that building wealth through the process of long-term compounding is the best strategy, how does one execute that strategy?
We find that selecting very high-quality dividend stocks with long track records of earnings growth, and critically, dividend growth, affords the investor peace of mind, and great wealth compounding prospects.
Investors have at their disposal countless tools and market strategists from which to take advice, but we think it need be no more difficult than starting with a list of stocks that have the best track records, such as the Dividend Aristocrats.
This is a group of stocks that have at least 25 years of consecutive dividend increases, and are members of the prestigious S&P 500 index. By achieving Dividend Aristocrat status, all 65 companies have demonstrated long-term competitive advantages, the ability to weather tough economic periods, and sustainable earnings growth.
All of these characteristics are critical for long-term dividend growth, but in addition to that, the management team must be willing to return ever-higher amounts of capital to shareholders over time. By adding all of these characteristics together, one finds the perfect recipe for long-term wealth compounding through dividend stock investing.
The Dividend Aristocrats are a great place to start, but if the investor wants even more assurance of long-term dividend growth, there is yet another list with even greater requirements for dividend longevity. The Dividend Kings are a group of just 44 stocks that all have at least 50 consecutive years of dividend increases.
Considering there are thousands of stocks listed in the US alone, the fact that there are only 44 in this group makes it extremely exclusive. The Dividend Kings are the best-of-the-best when it comes to dividend longevity, and we often highlight this group as a way to begin screening for dividend stocks to buy for that reason.
Regardless of which list is used to find great dividend stocks for the long-term, investors must determine which strategy to pursue. For instance, there are dividend stocks with higher current yields, ones with strong dividend growth prospects, stocks with high levels of dividend safety, and of course, those with some combination of those factors.
Each has its own merit, and depending upon each individual’s goals, the best mix of these characteristics can certainly vary. Investors closer to retirement would probably opt for a portfolio with a higher current dividend yield, which would provide more income to the investor. Retired investors, or those close to retirement, may also prioritize dividend safety.
That is, the ability for the company to continue to pay and raise its dividend even in the event of a recession. Investors needing to protect their income would value yield and safety, but those that are further from retirement would likely favor dividend growth.
The reason is because if an investor is 20 or 30 years from needing the income from dividends, there is more time for compounding to work its magic. For stocks with high rates of dividend growth, earnings growth tends to be higher, which can lead to capital appreciation over the years.
In addition, strong levels of dividend growth means that the investor’s yield on cost is likely to be quite high by the time retirement comes around. That’s why it’s important for each investor to assess their goals, pick the optimal mix of characteristics from the available high-quality dividend stocks, and stick to the plan.
While there are many strategies to try and compound wealth over time, we believe that the best one is to find high-quality dividend growth stocks, create a plan that is oriented towards long-term goals, and let the magic of compounding do its work.
This strategy requires very little time investment from the individual, generates very low fees, and lower taxes that are paid less often than shorter-term strategies.
We see the Dividend Aristocrats and Dividend Kings as the best places to start the search for a new dividend growth stock to buy, as these exhibit the favorable characteristics a long-term dividend growth investor needs.
By following these simple rules, we believe that even beginner investors can build significant wealth over time.