Here is a continuation of my previous Strategy post, part 1. This time I would like to write about each part of my strategy more in detail, so you can see how I invest.

In the previous post I mentioned that I apply a few different strategies and use different accounts for those strategies. The reason for using different accounts is that some trading or investing has different requirements on cash management and it can be difficult to keep finances in an account organized.

I am a mechanical engineer and I like to have all things organized, sized, and put together exactly as any operational manual says in order to function well. Thus I like to have different accounts for different strategies.

 
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You may not like it that way and keep all your finances and investments together. If it works for you well, there is no need to change what you are doing.

Originally, I used only one account for my options trading and dividend growth investing at the same time, but many times I run into a situation that my options maintenance requirements prevented me from buying a stock I wanted.

Why dividend growth investing?

It was a long journey for me to land on this strategy. I tried almost everything out there, but no strategy satisfied my hunch: income. When my account was small I always was asking myself a question: “Where can I get more money to invest more?”

I wasn’t satisfied with my contributions to my account I did every month. I wanted more money contributed to my account every month which I could take and invest into more stocks.

At first, I invested into growth stocks. I envisioned myself hitting home runs every month. I doubled or even tripled my account at some point, but then I lost everything quickly. This was an eye opener. I realized that all gains I had were not sustainable and I couldn’t be sure whether I could repeat them next time. And losses were eating up my account value more than I was able contributing to it.

Then I came across dividend paying stocks. At first I wasn’t impressed. I considered 3% income too small to make any difference in my account and dividend paying companies too big and lazy to make any capital gains.

I didn’t see the power behind them – power of compounding and growth.

Once I realized how dividend growth stocks work and how they can make you rich faster than any other investment and most important – they can deliver additional contributions to my account, I knew, this was the strategy for me.

 
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Why dividend growth companies are superior?

People who do not invest in dividend stocks say that those companies are limiting their growth. When they pay a dividend, they have less money available for their growth – reinvestment, R&D (research and development), or capex (capital expenditures), and that is the reason, why they lack behind growth stocks.

I thought the exact same thing when I believed I could make more money investing into more volatile growth stocks.

But the reality is different. The way I look at it is that growth stocks are promising you a fortune at some point in the future, which may not happen if you do not buy low and sell high, while dividend paying companies are making you richer slowly over time and during the time before you get to the “some point in the future”.

So ask yourself a question – do you want to wait 20 years for a promised fortune or do you want to receive part of it today?

 
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Here are the reasons why I see dividend companies superior to any other companies:

It is a known fact that 50% of all gains of S&P 500 is made of dividends. So why not let your account have the same?

Dividend companies are more cautious with their capital expenditures than their nonpaying peers. Since they have less money left to invest, they invest wisely. I read a study comparing two companies, one was a dividend payer, the other wasn’t paying a dime. While the first was carefully selecting their acquisitions, the second was acquiring one competitor after another in a quest for getting stronger. Later, acquisitions of Leer hurt the company and it almost went bankrupt.

Dividend companies tend to grow at the same rate as their dividend growth. Have you ever noticed that many times you check a dividend yield of a company it states a certain yield, for example 3%, almost forever? When I was investigating dividend investing I checked JNJ yield and I was watching it for a few years. During that period of time, it always indicated the yield oscillating around 3%. How is it possible when the company grows its yield by 9% annually? I bought JNJ many years ago (at that time for a different reason that dividend growth investing). Back then it was trading around $54 a share and its yield was 3.5%. Today, JNJ is trading at $88 a share and its yield is 2.9%.

Dividends are great indicator of company’s health. No matter what Wall Street thinks and how deep they trash the stock because of whatever irrational reason, the company is healthy if it still can afford paying and increasing the dividend.

 
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Power of compounding

Here comes the best part of dividend investing and why it is a far better strategy than anything else. Since the companies share their income with you now and not anytime in the far distant blurred future, you can take that income and do the following:

 

• spend it
• reinvest it

 

If you buy a growth stock, you have nothing left after the purchase. You have to contribute your own money to buy more. You now have to wait for the stock to appreciate in time and sell it in order to make a profit. If you do not sell it, you risk that the stock plummets and erase all your gains.

 
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If you buy a dividend stock, you are also waiting for it to appreciate in price and during that waiting time you collect dividends. Then price appreciation isn’t that important to you and you can wait as long as you wish. If the price plummets, you do not mind it, because you are still collecting the same and growing dividend. If the price plummets, you can take that dividend and buy more shares. And you do not have to add more money to your account. And as you buy more shares, you start receiving even more dividends. It is that simple.

Income

Now that you know why I love dividend growth strategy, formulating my dividend strategy is easy. Here are the steps I will be taking to reach my goal. Let me repeat my goal:

My goal is not to reach a certain amount saved or a certain account balance, but make sure all my portfolios can safely generate enough cash flow every month no matter how big the accounts are.

 
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Accounts

I will use this strategy fully on my ROTH IRA account.

I will use this strategy partially on my TD account as a value preserving tool and contributions generating tool. More on this in the next part.

 
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Money management

I will be saving cash through commission free ETF in my ROTH IRA account. With my current saving rate and dividend income I can reach my cash purchase amount in four months. During that period I let my free cash waiting in the ETF which also pays me nice dividend/distribution (currently 8.6%).

To summarize it, I will buy a commission free ETF using all my contributions and received dividends to save enough cash purchase amount.

Once I save the cash purchase amount, which currently is $1200, I sell a portion of the ETF to get $1000 out of it.

As soon as I get $1000 out of the ETF, I will purchase a dividend paying stock.

 
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Time horizon and saving phases

I have 25 years before I will be legally allowed withdrawing money from my ROTH IRA account. That is a plenty of time to build a nice nest egg. This allows me to split my wealth building effort into three phases:
 

1. aggressive accumulation phase
2. consolidating accumulation phase
3. retirement phase

 
Aggressive accumulation phase

I will dedicate 10 years to buying high yielding stocks such as MLPs, REITs or other industries which offer high yield. I will focus on companies with yield over 4.5% trying to get companies paying around 7 – 8% yield. I will look for companies which increase their dividends and have at least 1 year dividend history. I will not focus on the growth as much as on the yield. I will strictly reinvest all dividends back to these companies.

I will invest into true dividend growth companies only if they offer an excellent entry point (usually during market sell offs).

This phase will end in 2022.

 
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Consolidating accumulation phase

I will dedicate the remaining 15 years to buying true dividend growth companies. I will be looking for companies offering great growth and yield and focusing on growth more than the yield. I will be looking for companies paying out min. 2.5% yield but offering more than 6% dividend growth. The dividend income from previous accumulation phase should be large enough to help boost my portfolio and add dividend growth stocks quickly and let them grow for next 15 years.

This phase will end in 2037

 
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Retirement phase

In 2037 I will be allowed to start withdrawing my cash from ROTH IRA for retirement purposes. I know I can withdraw earlier all contributions, but this is not my plan. To retire early I have a different plan and different account.

Once I will be able to withdraw money from my ROTH IRA account, I will be withdrawing dividends only and I will be withdrawing 85% of it only and reinvest the rest.
 

 
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Read previous parts:

My investing Strategy – part 1
 

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