Every year right around the end of January, I try to plan out my dividend income and capital allocation goals for the year. I started doing this in 2017, continued the process in 2018, and still find the process useful enough that I’m doing it again in 2019.
At the most basic level, my planning process amounts to putting excess cash to work from our Big Fat Cash Pile AND trying to put that cash into smart places that generate a growing stream of dividend income. The devil is in the details of course.
This ‘reinvesting’ of excess cash, is part of a process I call external compounding (not to be confused with internal compounding). I write about this concept fairly often on my blog, so existing readers should already know how I differentiate between the two forms of compounding. (For everyone else, please check-out the posts I’ve linked to above!)
Funding A FI Lifestyle
While there are many successful ways to fund a financially free lifestyle (bond interest, annuities, real estate income, capital gains, and so forth), the Tako family funds our lifestyle primarily using stock dividends.
Yes, we have a few things mixed-in (like interest income, REIT income, and even earned income) — but a good 80% of our spending money comes from stock dividends in our taxable accounts.
Why not more from capital gains?
Well, if you’ve read this blog for very long at all, you’ll know that I don’t like to rely on market movements to provide for our family’s lifestyle. I have no idea if the stock market is going to be higher or lower in 10 years.
I won’t even guess! Speculation on the direction of the stock market isn’t my game. We’re farmers, not hunters.
Mainly, we try to spend our dividend income, not the capital gains the market randomly hands our way.
Our Dividend Record
Last year (2018) we earned a total of $51,230 in dividends and interest income. This was slightly below my 2018 dividend goal, primarily because I didn’t find places I liked for our spare cash.
My originally 2018 Dividend Growth Plan included investing $100k in fresh capital last year, but I only managed about $50k. Ooops! This is one of the reasons why we fell behind our dividend growth goal.
2018 was the first year our dividend income declined since 2013. Primarily the declines in 2013 and 2018 are due to major preferred share redemptions (outside of our control).
(Note: Almost all of the preferred shares purchased back in 2009 have now been redeemed, and it’s unlikely we’ll get that tremendous income opportunity again.)
One bad year is certainly not a trend, but I would like to turn this around in 2019 and see our dividend income begin growing again.
How Will We Grow Dividend Income In 2019?
To map it out, there’s three main ways our dividend income is going to grow in 2019:
1. Dividend Increases. One of the biggest areas of potential dividend growth in 2019 comes from our existing stock holdings. Given their history, the stocks we hold are very likely to increase dividends in 2019. Most good dividend growth stocks increase their dividend every single year, and 2019 should be no exception.
The economy is good, and unemployment is low, and consumers are still spending. I see no reason why the vast majority of our stock investments would have trouble raising their dividends in 2019.
Historically, the S&P 500 has raised dividends at a 6% rate annually (about 3% after adjusting for inflation), and for planning purposes, I’m going to use this 6% growth rate to estimate the increases we can expect in 2019.
2. Picking Up Stocks “On Sale”. If the opportunity presents itself, I’ll be hunting for sales in 2019. As the year progresses there might be a few buying opportunities in beat-up sectors. We’ll see how the year goes. I’ll keep my eyes open for any juicy bargains the stock market creates.
Generally I’m not a stock “hunter”, but if a some “fresh game” happens to stroll onto my farm, I don’t have an issue with taking advantage of good opportunities.
3. Growing Existing Long Term Holdings. When valuations are reasonable in 2019, I plan to continue adding to our existing long-term stock positions. These are stocks we hold long-term.
To continue with the farmer/hunter metaphor — This is like growing the size of our ‘farm’ by adding more land.
Typically this kind of stock investment will earn good returns on capital, and pays out a sensible portion of its earnings as dividends (I usually look for payout ratios less than 60% of earnings). These stocks represent the bulk of our taxable portfolios and will continue to earn good returns well into 2019 the future.
If we can get a good price, it makes sense to keep adding to my existing positions.
While those three investing strategies represent our best opportunities for dividend growth in 2019, the year won’t be without its difficulties. Despite selling pressure at the end of 2018, stock prices are still high. Yields are not great.
Currently, the S&P 500 is yielding about 2.04% at the time of writing. Even higher yielding stocks are only yielding around 3%. (Several banks and energy companies fit this bill and still have reasonable growth prospects.)
For planning purposes this year, I’m going to estimate I can invest our cash and earn a 2.5% yield.
Yes, I know that investments with much higher yields do exist, but at the cost of considerably increased risk (or poor growth prospects). I usually avoid high-yield low-growth stocks because they tend to be value-traps.
We don’t chase value traps, because I intend to sleep well at night… I don’t want to worry if the dividends are going to be cut and the investment is going to drop like a rock.
Passive Income Goals for 2018
Using my target yield for new investments at 2.5%, and dividend growth estimate of 6%, I’m going to set our 2019 dividend income goal at $57,000.
This goal represents $108k in new capital invested during 2019. Knowing how conservative I was last year this might sound like a bit of stretch — but if I don’t push myself to keep investing our excess cash just keeps piling up.
I think I can do it. I’m going to try at any rate. That $108k invested should be generate about $2,700 in new dividend income for the year. The remaining $3k should come from regular dividend increases, giving us a total of $57k for the year.
Just like last year, you’ll be able to follow along and watch our dividend progress throughout the year by reading our Dividend Income and Expense reports. I’ll publish the dividend totals every month.
Wish me luck in 2019!
While I don’t claim to have the ability to predict what the stock market will do in 2019, it really doesn’t matter much to a dividend growth investor like myself.
You see, stocks are just small pieces of businesses and the best businesses regularly spit off cash in the form of dividends.
I find this facet of stock investing to be a far more reliable way to generate cash flow than trying to regularly harvest capital gains.
There’s nothing wrong with capital gains of course (I like capital gains as much as the next investor), but those paper profits can appear and disappear in an instant.
My strategy remains the same as it has in previous years — Always be compounding money, and try to isolate myself from the swings of the market. Dividend growth investing is a perfect fit for this strategy.