Image source: Getty Images
I’m not trying to say that dividend-paying shares will produce better returns than ones that don’t. I also don’t think that every company that pays a dividend is a suitable fit for my portfolio – just because it pays money to shareholders doesn’t mean it’s a good investment.
However, dividend-paying shares suit me for how I’m trying to invest and the outcomes I’m trying to achieve. They also help me see opportunities and stay invested for the long term.
Consistency of investment income cash flow
The share market is notoriously volatile.
Just look at the last three years for how much the valuation of businesses can go up and down. The panic at the start of the COVID-19 pandemic created a huge sell-off (and a big buying opportunity). This year there has been another big decline for many stocks, largely spurred by inflation and higher interest rates.
I only buy long-term ASX (dividend) shares where I’d become more excited by a lower share price and want to buy more. That way, I can feel very confident that a decline – such as this year – represents an attractive buying opportunity for my holdings rather than raising uncertainty for me.
A company has much more control over its dividend than its share price.
Assuming it has a sufficient profit reserve and cash balance, the board of directors can decide on the appropriate level of the dividend. This is useful for my philosophy because companies can pay a consistent dividend, and even grow it, during harder times.
By focusing on the investment income from my ASX dividend shares, I can ignore the noise of the market gyrations.
The difficulty of selling
I think buying investment is pretty easy, but deciding when to sell is tough.
One of the most useful pieces of investment advice is to “hold onto your winners”. There aren’t too many ASX shares that do very well over the long term. Investors that bought names like Apple, Altium Limited (ASX: ALU) and Microsoft many years ago would have done well by simply holding onto those great businesses.
But how is an investor meant to benefit from the growth of the value and profit of those companies? I don’t want to reduce my ownership of great businesses, I want to keep owning them. I don’t want to trigger capital gains tax events every time I want some money from my portfolio. It could be disappointing to (need to) sell at a time when share prices have slumped.
It can also be tricky knowing when to sell if things go wrong with a growth company’s plans. Is it a temporary blip and worth holding? Or is it a permanent setback, the thesis is broken and it’s better to move on to something else?
Should investors hold onto a business until its industry becomes obsolete or perhaps a competitor takes over?
Some of those are hard questions to answer. I think it’s easier with certain ASX dividend shares.
Are businesses better off by retaining profit?
People could say to me that it’s better for a good business to retain its money and re-invest it for more growth, rather than paying dividends.
The financial needs of each company are different. It could be possible to pay out a third or a half of its profit and still grow as much as it would have had it retained all of its money. Maybe investing all of the profit each year would lead to reducing returns on those investments, leading to a lower return on equity (ROE) and other financial measures.
But, there are some great examples of businesses doing well and not paying a dividend, such as Berkshire Hathaway and Xero Limited (ASX: XRO).
For Australian-based companies, it can make sense to pay dividends because of the franking credits that they generate. ASX dividend shares that pay fully franked dividends can unlock some of those franking credits for investors, providing stronger after-tax returns. The boost of franking credits often isn’t captured in the returns quoted about ASX shares.
My long-term goal
I am hoping that one day, long before I reach 65, I’m able to build a portfolio of dividend-paying shares that sends me more cash annually than I’d want to spend annually in retirement.
When that happens, I can theoretically retire (if I want to) and just live off the dividends. Hopefully, my dividend income will keep growing from that point and I can spend more each year.
In another article, I’ll write in detail about some of the ASX dividend shares that I’m investing in to grow my dividend income (and will also hopefully grow in value). But, two of the names that I’m going to write about include Washington H. Soul Pattinson and Co. Ltd (ASX: SOL) and Rural Funds Group (ASX: RFF).