The Dividend Man Strategy

What is The Dividend Man Strategy?

The Dividend Man Strategy is to invest in the shares of dividend-paying companies.

This strategy achieves the long-term investment goal of most investors, and has a low risk of failure.

What is the Long-Term Investment Goal of a Typical Investor?

The long-term investment goal for a typical investor is something like:

• "I want sufficient income to finance my desired lifestyle, for the rest of my life"
  

• "With low risk of failure". Failure would be if your investment income is less than you need.

If you are retired and need $50,000 to pay for your preferred lifestyle in 2013, you want your investments to provide an income of at least $50,000 in 2013. Anything less is failure. And you want it to finance your desired lifestyle for the rest of your life, which means it must keep up with cost of living increases.

If you are not retired your goal might be a lifestyle after retirement which would cost $50,000 in 2013. Failure would be the income from your investment portfolio not growing to equal $50,000 plus any increases for cost of living, by the time you retire.

Australian Evidence of Investment Performance in the Long Run

Australian evidence shows that in the long run dividends from investing in the average of the stock market grow at a rate which is at least equal to inflation. The All Ordinaries index is used as the average for the stock market. Overseas evidence produces similar results.

The graph shows the performance of cash dividends, share prices, interest income, and cost of living (CPI) in Australia from 31 December 1983 to 31 December 2012. All four are shown as an index starting at 1,000 at the end of 1983.

• Cost of Living (inflation): Prices rose 180% (3.6% p.a.), as measured by the consumer price index (CPI). Goods and services which cost $1,000 in 1983 had increased in price to $2,800 in 2012.
• Cash Dividends: Dividends rose 610% (7.0% p.a.). If you received $1,000 dividend income in 1983, it grew to $7,100 in 2012. Dividends grew much faster than inflation. This growth occurs even though the dividends were spent every year, and not reinvested.
• Share Prices: Share prices rose 490% (6.3% p.a.).  The value of a $1,000 share portfolio on 31 December 1983 grew to $5,900 by 31 December 2012.
• Interest Income: Interest income fell 71% (minus 4.2% p.a.). If you earned $1,000 interest income in 1983, it fell to just $290 in 2012.
• Value of an Interest-Earning Investment: An interest-earning investment (such as a term deposit with a bank) did not change in value over the 29 years. $1,000 on 31 December 1983 is still $1,000 on 31 December 2012, but its purchasing power was reduced by 64% (minus 3.5% p.a.) due to the increase in the cost of living.

Long-Term Risks Faced by Investors

The three major long-term risks for all investors are:

1. Inflation (Cost of living increases)

2. Investment income falling

3. Out-living your investment portfolio

Investing in the stock market beat all three of these risks in the long-run:

• Dividends grew much faster than inflation. 
• The long-term trend of dividend income was up.
• As long as dividends stay above the cost of living you will not have to sell any shares. Based on the last 29 years evidence of not having to sell any shares to keep up with the rising cost of living, share portfolio could remain intact for the whole of your life.

Investing in interest-earning assets failed all three of these risks in the long-run:

• Interest earnings fell while inflation pushed up the cost of living. This fails the first two risks.
• With falling interest income you will need to eat into your capital to maintain your lifestyle. Reducing your capital will further reduce interest income, resulting in a greater reduction in capital the following year. This cycle keeps repeating, so there is a high risk that your capital will be totally depleted during your lifetime.

The Dividend Man Strategy does better than these results

There are three reasons why the results from The Dividend Man Strategy would be better than reported above:

• Franking credits on dividends, introduced in July 1987, have not been included in the results. Franking credits add another 228% (1.0% p.a.) to the dividend increases. Dividends of $1,000 in 1983 became dividends plus franking credits of $9,378 in 2012, which is 8.0% p.a. growth.
• The results are based on the performance of the All Ordinaries index (a measure of the stock market average), which includes non-dividend paying companies, and other poorly performing companies.
• The Dividend Man Strategy excludes non-dividend-paying companies and other high risk and low performance companies.

Future posts will describe the important features of The Dividend Man Strategy which make it perform better than the market average.