Having worked as a banker and then a financial consultant, I've the luxury of meeting many different people with varying risk appetite and expectations for their wealth accumulation needs. Over my 8 year career, I can say with great certainty that dividend investing is a far more palatable idea compared to investing for capital gains.
There are a couple of interesting observations I made over the years. People who invests for income don't seem bothered by price fluctuations. In reality, most of them don't check. They only check to see that the dividends are credited into their bank accounts...
Yet, despite the high demand for dividend investing, I've never personally been able to wrap my head around the idea for someone of my age (in my thirties). I'm a big fan of growth investing and honestly within my own portfolio, the only instruments that generate an income for me are my endowments. All my investments are focused on capital gains.
In this article, I offer 3 reasons why I prefer investing for growth over dividends at my age.
1. Dollar cost averaging works better for volatile investments
Largely due to my age, I'm at the stage where I am building up my capital and have plenty of big ticket purchases waiting for me. Building capital means that while I am investing aggressively, I have yet to amass a sizeable lump sum where the dividends can provide a meaningful amount to replace my expenses. It also means I'm investing regularly through dollar cost averaging.
Most dividend income ranges between 4-5%pa
On average, most dividend income range between 4-5%p.a. A $100,000 investment would then yield about $4,000 - $5,000 income a year which translates to about $300 - $400/month. While this is good, I see myself working for at least the next 20 years and thus have a sufficiently long runway to accept greater risk in the market. On top of which, I need to spend huge capital within the next 10 years on big ticket items like housing, car, renovations, etc. Given my timeline, I feel a progressive investing approach on a dividend strategy is too slow for my risk appetite.
Dollar cost averaging (DCA) thrive on volatility
Typically, the benefits of dividend investing is lower volatility and greater stability. That's why retirees love to invest for dividends. Equity funds or growth stocks on the other hand may not provide income but have greater volatility and potentially much higher growth. This plays to the strengths of DCA as you buy more units when prices are falling and less units when prices are climbing.
It also means that prices may not necessarily need to grow back to its original purchase price and you might already be profitable due to consistent investing.
In the illustration table above, I borrowed the table from HSBC on their article regarding DCA. Using the example provided, I did a simulation if we really invested $1000/month in this investment for a year...
Here's the findings:
Up till month 7, the investment wasn't profitable due to dropping prices.
Month 8 broke even but the share price was $0.85 instead of the original buying price of $1.
Assuming it went up to $1.09 on month 12, the value of the investment was $14,454 with only $12,000 invested. That's about a 20% gain.
On the other hand if $12,000 was invested at $1 and the price went up to $1.09, the gain would only have been $13,080 which is a 9% gain over the same period.
From the illustration, we can see the effect of DCA compared to lump sum if the investment undergoes a pretty volatile period. Technically, the more volatile an investment is, the more effective DCA would work. Dividend driven investments typically do not have such huge volatility hence even though we have the option to reinvest the income, it's unlikely the benefit would be equal.
2. Dividends are little when capital is small
For dividends to make sense, we need a capital of at least $250,000 - $500,000. Assuming a dividend rate of 4% - 5%, a quarter million to half a million capital would yield about $1,000 - $2,000 a month income. This is reasonable as it helps to defray expenses. However, most people in their late 20s to early 30s are still amassing this figure. Above all, we likely need it for wedding, housing and family planning.
Assuming a generous $3,000 per month in investments, you only set aside $36,000 per year which amounts to a miserly $1,800/year in income. Above all, in the first year, your income will likely be less than $1,800 as you are still in the process of accumulation.
Another question I like to ask investors who invest for income is what do you do with the income while you are still working? Many clients I used to serve in the bank actually leave these extra monies in their bank accounts. What's the bank account interests? Usually 0.05% unless there's promotional rates. Does this behaviour make sense then?
The returns reflected on dividend funds factsheet is based on reinvested dividends
Which leads me to another point. If we base on funds, the returns reflected on fund factsheets are based on the assumption that the dividends are reinvested. Which brings me back to the main point, you still don't get to enjoy the income because it needs to be ploughed back into your investment in order to fulfill their projected returns.
In my case, my risk appetite can stomach greater volatility, I'm dollar cost averaging and do not intend to use the income generated since I'm still working and have surplus savings each month... I'm thus better off investing in investments which focuses on growth.
If we want to go technical (which I don't), there are available literature online explaining why dividend funds are usually less volatile and returns more muted. In terms of stocks, for companies who can afford to distribute income back to shareholders, it generally means there's limited need to deploy the resources for expansion of the business interest and too much surplus funds available. This is also why high growth tech companies in the US usually do not offer dividends as the value of the business grows more if the resources are redeployed within the business. That is also why, usually a multi-bagger investment is high growth not a stable investment like McDonalds.
Basically, in the earlier years when I really have little need for extra income, I'd prefer placing my funds in areas where there's room for maximum growth.
*Do note that higher returns come with higher risk. You still need to ensure your risk appetite can stomach the market fluctuations.
3. Maximize my youth
I'm a firm believer of practicality. Based on my own situation, I see myself working for at least another 20 years. I have time on my side. If we look at the DCA illustration shown above, volatility suits people with time and who can make regular contributions. Do I believe I'll guarantee plus chop make money? No... that's why I still diversify my funds into other instruments and not put my entire savings into investments.
However, I believe that statistically, the odds are in my favour as long as I keep my portfolio well diversified and long term. I also dare to take more risk because I believe I have the runway to earn back the money invested if my investments go south.
Above all, I know I'll be liquidating most of my investments in the near term to fund big ticket purchases. If my investments gains more within my required time frame, the less capital I need to liquidate, the more buffer I have. This means a more aggressive approach over an income based approach which offers more stability works for me.
Caveats
The above 3 reasons work for me because of the following considerations.
Financial planning is about balance. I'm not putting all my money into high risk investment and I've other asset classes that diversify my risk based on my comfortable timeline.
I have income generating instruments, just not in investments. While some may challenge the notion of why not investments, my basis is to preserve my capital not run the risk of potentially losing it. (imagine a market downturn where your high and moderate investments are all stuck at the same time)
I need to have alternative instruments to manage my sanity and to prevent myself from liquidating my investments during volatile periods. This only works when I psychologically know I've available money elsewhere.
I'm not against dividends and have intention to convert some of my investments to income generating in the future. This will likely happen when I'm closer to retirement or at least after my big ticket purchases are done and I've sizeable capital to generate income streams to replace my active income.
My current priorities are to earn as much as I can given that I still have the energy and timeline to work hard and take risks.
Summary
In my opinion, there's no right or wrong way to investing. There's only what's suitable for you. The purpose of this article is to offer an alternative perspective. I feel that too many people opt for income investing simply because of the psychological comfort that money is coming in. However, depending on your instrument and priorities, this may not be the best use of your money and your timeline to meet your goals.
Once you pass up on certain windows of opportunity, you can't reverse time. It's perfectly okay to opt for income investing with all factors considered. It's not okay if it's a result of ignorance and hearsay.
After reading this article, you may have some questions or may want to find out more about whether you suit dividend investing or growth investing more. You can reach me by dropping me a message.
Be sure to share the article if you feel this information is helpful. You will enable a lot more people to learn about investments.
About Janice I specialize in portfolio optimization (ensuring you get maximum value for every dollar you put in) and retirement planning. Clients look for me primarily to outsource their retirement planning needs so that they can focus on other aspects of life that interests them. Many of whom are very good in earning their incomes in their respective professions and wish to ensure their monies continue to work harder while they focus on what they are good at. Refer to client testimonials here. I've helped many clients who are referred to me reduce the costs they are paying for their insurance or help provide solutions when they deem they are stuck with huge commitments bought when they were younger but unsuitable for their present life stages. You can reach me at 94313076 or my social media accounts on Facebook and Instagram. Disclaimer: The content created are based on my personal opinions and may not be representative to everyone or any organisation. If you have any doubts or queries pertaining to insurance or investment, please seek professional advice from a trusted adviser in an official setting. You may also reach out to me if you do not have a present adviser using the message box under 'Let's Talk'.
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