3111: The Dividend Aristocrats by Sean Owen with Mr. Money Mustache on Stock Market Investing

[00:00:00] This is Optimal Finance Daily, The Dividend Aristocrats by Sean Owen with MrMoneyMustache.com. Now that you've had an introduction to the wonderful world of dividend investing, you might ask yourself, what could be better than a company that pays you every quarter for the privilege of having you as a shareholder? How about a company that gives you a raise every year?

[00:00:28] It turns out that there are a number of companies out there with a proven track record of doing exactly that, and there's an easy way to find them. Enter the aristocrats. No, I don't mean the aristocrats from the infamous joke you may have heard of. The S&P Dividend Aristocrats is an index that consists of companies that have raised their dividends every year for at least 25 years in a row.

[00:00:55] This is an elite club indeed, because if a company ever misses a single dividend payment, or ever fails to give investors a raise, then it's booted out and must start that 25-year clock all over again if it wants to get back in. The index currently includes many familiar companies like Johnson & Johnson, McDonald's, and Walmart, but there are others on the list that aren't necessarily household names.

[00:01:24] Companies like Abbott Labs, Dovercorp, and Pitney Bowes may not make many headlines, but they also have paid increasing dividends for 25 years or more. That period includes several nasty recessions, including the most recent one, which is the worst since the Great Depression.

[00:01:45] The share prices of these companies may have fluctuated during these rough patches, but they kept raising their dividends relentlessly through it all. Boring is best. Many people think of these sorts of stocks as boring. Traders often deride them as being for widows and orphans. Many will tell you that a company that has paid increasing dividends for 25 years is too big to grow.

[00:02:14] My response to that is, as my dad would say, horse hockey. The dividend aristocrats have outperformed the S&P 500 over the previous 5, 10, and 20-year periods. Quite handily, in fact. There's another way to look at it. A company that pays steadily rising dividends is a company that makes so much money year after year that it simply can't use it all.

[00:02:40] And they believe the best use of all that extra cash is to reward their shareholders. That sounds like a company I want to own. An example from Warren Buffett. For a great illustration of the amazing power of dividend growth investment in general, and dividend aristocrats in particular, we need look no further than the world's greatest investor.

[00:03:04] Warren Buffett established a position in dividend aristocrat Coca-Cola in 1994. Check out his comments on that investment from a letter to Berkshire Hathaway shareholders. Quote, Coca-Cola paid us $88 million in 1995, the year after we finished purchasing the stock. Every year since, Coke has increased its dividend.

[00:03:30] In 2011, we will almost certainly receive $376 million from Coke, up $24 million from last year. Within 10 years, I would expect that $376 million to double. By the end of that period, I wouldn't be surprised to see our share of Coke's annual earnings exceed 100% of what we paid for the investment. Time is the friend of the wonderful business, end quote. You heard that right.

[00:04:00] By 2021, if Coca-Cola stays on its current trajectory, the shares Buffett bought will earn more in dividends alone every year than his entire investment back in 1994. How's that for boring? My shares have gone down? Awesome! There's a sort of magic in investing in companies like these. When you stay focused on collecting your paychecks from the companies you own, rather than the share price,

[00:04:27] you can ignore the wild fluctuations in the stock market that keep less enlightened investors awake at night. You can simply sit back and collect ever-increasing income from your portfolio. In fact, if you reinvest your dividends, which I highly recommend you do, you might just learn to love it when your favorite company's shares go down. How can that be? Because those reinvested dividends will buy you more shares when the price is low,

[00:04:56] which will in turn earn even more dividends in the years to come. Investing in the aristocrats. So, what's the best way to invest in the dividend aristocrats? One simple way is this. The SPDR S&P Dividend ETF, known as SDY. This is an exchange-traded fund that tracks the S&P High Yield Dividend Aristocrats Index.

[00:05:26] This is a slightly different index, which includes dividend aristocrats from the S&P 1500 rather than just the S&P 500, but it has the same 25-year dividend growth requirement. It has reasonably low expenses and currently sports a very respectable 3.3% dividend yield. If you don't want to put a whole lot of time in learning how to evaluate individual stocks,

[00:05:56] you could very well just stop here. The holdings and SDY are quite well diversified and represent many of the most rock-solid companies across a wide variety of sectors. It's a portfolio that will let you sleep well at night, whichever way the market's moving. An elite cheat sheet. If you prefer to pick your own stocks, whether you're a seasoned pro or just starting out, there are no shortcuts.

[00:06:26] Doing your homework on each and every stock you consider for investment is absolutely essential to your success. It can be a daunting task when you have thousands of stocks to choose from, The 2012 High Yield Dividend Aristocrat Index only has 61 companies on it, though. If you narrow your search to these, doing your due diligence suddenly feels a lot more doable.

[00:06:53] In fact, it's perfectly feasible to do a thorough analysis on each and every company on the list. And that's precisely what I recommend you do before investing a dime, especially if you're new to investing. For a great primer on valuing stocks, check out The Intelligent Investor by Warren Buffett's mentor, Benjamin Graham. Read it and then get to work combing the aristocrats for bargains. It'll be time well spent.

[00:07:22] You'll be a much better investor when it's done. And you'll have an opportunity to practice the number one most important skill for any investor to have. Patience. You just listened to the post titled The Dividend Aristocrats by Sean Owen with MrMoneyMustache.com. When I started my conference, it felt like diving into the deep end.

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[00:08:41] Sign up for your $1 per month trial and start selling today at shopify.com slash OFD. Go to shopify.com slash OFD. Shopify.com slash OFD. I found this article pretty interesting because I don't spend much time thinking about dividends. But my curiosity over this article led me down the rabbit hole of some pretty interesting debates on the interwebs.

[00:09:12] Basically, there are a number of things a company can do with their profits. They can pay them out as dividends. They can use them to build the company. They can buy back their own shares. Or they can buy other companies. When a company chooses to use their profit to pay dividends, it's great for shareholders in the short term. But there's an opportunity cost there because that's money that's gone forever. And that's money that they could have used to grow the company.

[00:09:40] So depending on how you look at it, choosing to focus on dividend stocks could be seen as trading growth for income. The other thing to consider is that in a taxable brokerage account, you will be paying taxes on those dividends every year, even if you reinvest them. The good news, for those in the 15% or lower tax brackets, qualified dividends are taxed at 0%. But for those in the 25% and higher brackets,

[00:10:09] you will be paying tax on it. And ordinary dividends are taxed at your regular marginal rate, same as any other income. So people already earning a high income might not find a focus on dividend investing as advantageous due to the tax implications. It seems to me that many buy and hold investors don't prefer a focus on investments that pay dividends because it's more beneficial to control income for tax purposes

[00:10:38] when drawing down on a portfolio. When you receive a dividend, you have no control over the size of the dividend or the timing of receiving it. And 100% of the money you receive will be considered income. Whereas when you sell shares, only the difference in cost from your purchase price may be subject to taxes. And you can much better control when you receive that income when selling shares to ensure it's not bumping you up into a higher tax bracket.

[00:11:07] I'm seeing a lot of pros and cons to an investment strategy that focuses on dividends and is all highly dependent on your circumstances and preferences. That should do it for today. Have a happy rest of your day and I'll see you on the Friday show tomorrow where your optimal life awaits.