In a potential tie with the readers who contact me telling me how they are in the early stages of changing their financial life and already seeing the benefits, some of my favorite letters are from readers who have built substantial positions in great American enterprises, and write to me to tell me how much it works.
To the extent that I have been able to pick up on general conclusions, I have noticed this:
1. When people who are financially successful reflect upon their lives, there is often a small handful—sometimes even just one—of ownership interests held for a long time that end up being responsible for their success
2. The method of acquiring the stock does not fit our easy example types—it’s not a $10,000 investment held for thirty years, or $100 invested every months for two decades. Rather, it’s lumpy and comes in spurts, reflecting the ebbs and flows of life.
Recently, I heard from reader Daniel F. who managed to build up a position of $100,000 in Pepsi stock by the end of 1993, and he has been living off the dividends ever since then (more precisely, he says that he reinvests the third quarterly dividend payout each year just so he can goose his income a bit the next year, and uses the other three dividends to partially live off)—yet another life story that proves that dividend investing isn’t something that requires you waiting until retirement to benefit from.
You know what I like so much about hearing these stories? Daniel was able to realize very real benefits from his Pepsi holdings during the three times per year that he cashed his dividend checks, and even though he was directly benefitting from the company financially, he was still able to get richer. That $100,000 he had built up by 1993 is now worth over $841,000, and he was able to enjoy some of the money along the way.
In the very abstract, when you own an excellent business, you are getting richer in one of three ways:
1. The company is growing profits either organically or through share buybacks that remove owners so that each investor can lay claim to a higher percentage of the remaining ownership pie.
2. The company is paying out some of those profits in the form of dividends.
3. As the company grows profits, the total net worth value increases (e.g. Pepsi usually trades at 20x profits, so if it grows profits from $4 to $8 over a seven-year stretch, it turns a $80 stock into a stock worth $160).
There are a lot of perks that come with having a portfolio consisting of $100,000-$450,000 by the time you reach age 40, particularly if some of it is in a taxable account. You can cash some chips in by taking option #2 out of the long-term wealth creation process so you can actually benefit from the investing process (which is why you do it in the first place) while still getting richer due to the company growing profits per share so that future dividends will be higher even as you spend the ones you collected and your net worth will climb due to the growing profits being valued at 20x earnings over the long term.
Those 9,000+ shares of Pepsi are a great friend to have—you get a check of $5,895 every three months that you get to spend as you want, and then next, the amount you will be sent is even higher as people in America continue to have Quaker Oats for breakfast, Pepsi with their lunch, and Lay’s potato chips as an evening snack (Pepsi has hundreds of other brands).
Some of the people who regularly read this site are part of this country’s very, very small minority of people who are on pace for an overfunded retirement (“overfunded” isn’t the right word, but I couldn’t come up for a better word to capture the experience of a family spending $80,000 per year in retirement but taking in $150,000 from passive income sources). If you are in the category of people who get a couple hundred thousand in the bank at an early age (early 30s to late 40s), it is worth taking the time to contemplate whether you should be cashing some of your dividends as you go.
For most people, there’s not going to be a huge quality of life difference between reaching your 60s with $2.1 million or $2.6 million. But there is a huge benefit to taking that extra vacation with your kids when you’re 40 or upgrading your seats at the Bruce Springsteen concert. It’s worth thinking about which experiences are worth more than a couple hundred shares of Pepsi stock that could get reinvested along the way.
I’ve written about this before, but the real joy of dividend growth investing starts to hit you as you cross the six-figure mark with your holdings. I hope each and every one reading this gets to experience it. Those $5,800+ dividend checks I just mentioned get replenished with more money each year. It’s such a different style compared to how most Americans are conditioned to think about money—you think about some waitress working 12 hours per day at Steak ‘n Shake so she can bring in $5,800 over three months if she is lucky. And if she wants $5,800 over the next three months, she is going to have to sell 8 hours every day to the restaurant chain to make that happen. If she doesn’t grind it out, no money comes.
The dividend growth investing strategy is about reaching a point in your life where you can get beyond giving up your life in the form of labor you may not desire to do so that the money comes regardless of how you allocate your time. Once you start collecting $5,800 quarterly dividend checks from the kind of company we frequently discuss here, you’ve won. Even when you spend your money, you continue to get richer each year due to the plain growth of the business. You don’t need to reinvest to boost your way to the promised land, anymore. You’ve unleashed the beast, and you’re free to spend every dividend check that comes your way. You’ll still continue to get richer over time, anyway.
Originally posted 2014-12-26 08:00:45.