Watching the way the stock market goes up and down, and following the various indexes as they bounce around, it becomes very easy to forget that underneath the FTSE or S&P 500 is a bunch of actual cash generating businesses (except when the said business are losing money of course). In the last few decades especially, investors have often come to look at markets as a place to pick what they hope will be the big winners in a capital appreciation game. Yet originally stocks were a place where the wealthy parked cash for the long term in order to gain a safe income stream.
Somewhere along the way the stories of folks who had won big by getting in early on companies such as Microsoft have changed the way people look to earn money out of the markets. This change has essentially made markets more akin to a casino for most, instead of a place where conservative investors find solid companies and share in their long term prospects. Even though so many profitable companies continue to pay dividends which offer a very attractive yield, nowadays Wall Street as a whole seems to care far less about long term viability than whatever short term results were produced in the last quarter.
If you are looking to generate an income stream over the coming decades, you might want to consider the strategy of diversifying across a spread of boring, blue chip companies in industries that are likely to survive the current wave of disruptive technologies. Many have a corporate policy of paying steady dividends regardless of short term results or gyrations in the markets. The key is to find companies that trade at prices relative to the dividend that give a good yield in percentage terms. If you are happy with the yield and have purchased companies you believe in, then forget about the fluctuations in price afterwards.
Think about companies that you believe will still be around in thirty years, and rank them according to dividend yield. If you follow this strategy, you need to ignore the ups and downs of the “cash out value” of your portfolio. Sure the overall market may and probably will crash every so often, but it will always come back up again in due course. As long as you continue to receive your income stream, you really should care less what value people are willing to bid for assets that you do not intend to sell.
Diversification across companies and sectors is extremely important when investing for dividends. Any one company, no matter how long they have had a steady policy, can suddenly decide to do a 180-degree turn. When a company like this finally drops or reduces the dividend, the price usually drops off a cliff as income investors all simultaneously dump it. The larger the number of stocks in your portfolio, the less the impact if any one company changes its dividend policy.
While personally I think it would be better to wait until the next crisis or severe correction to invest in dividend stocks, as the yields will go up in percentage terms as the price drops (you get more shares per dollar and thus a larger income stream). You may not have the luxury of waiting and would like to generate that income stream now – if this is the case, you need to be more selective to make sure the average yield equates to an income that you can live with. Whatever you do, don’t panic and sell out when the next crisis comes. If the companies in your portfolio survive, your income is safe regardless of what the current levels of the FTSE or the S&P are.
David Mayes MBA provides wealth management services to expatriates throughout Southeast Asia, focusing on UK Pension Transfers. He can be reached at firstname.lastname@example.org. Faramond UK is regulated by the FCA and provides advice on pensions and taxation.