Why I Vastly Prefer Dividend Growth Investing To Index Investing

I haven’t expressly written before about the differences between dividend growth investing and index investing, and why I prefer the former over the latter. But, always better late rather than never and so I find myself compelled to put my thoughts to paper.

Before I delve too deep into this, it should be noted that I find index investing to be a fantastic strategy for a great many people out there, and probably the vast majority of investors would do better to invest in a small group of high quality, low expense index funds and be done with it. It’s extremely easy to manage, very passive and usually a yearly or semi-annual portfolio rebalance is all you need to keep a proper asset allocation to stocks, bonds, real estate, etc.

Okay, with that aside let’s get into it. 

First, let’s define exactly what an “index fund” actually is. Per investopedia an index fund is defined as:

A type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover. 

There are thousands of index funds available for an inclined investor to research, and invest in. For simple comparisons today, I’m going to use VIG, which is Vanguard Dividend Appreciation, since it’s fairly close to an apples-to-apples comparison to dividend growth investing. This fund typically focuses on businesses with at least a 10-year track record of dividend growth.

Okay, let’s talk about fees. 

I pay $7.00 per transaction with my broker, Scottrade. I typically have about two transactions per month on average. That’s $14 per month, for a total of $168.00 per year. We could safely round this up to $200, to make room for months when I have more than two transactions. Based on the last published value of my Freedom Fund, that works out to about .19% of my total assets on a yearly basis.

Index fees are famously heralded for their low fees, and rightly so. Many active mutual funds charge a pretty hefty fee to pay their directors and fund managers for the fund management services they provide, whereas index funds typically are not as actively managed. VIG, for instance, charges an annual management fee of just .13% of total assets under control. So, this must be the better way to go, correct?

Not so fast. 

My “management fee” will only decline over time as my portfolio value, and total assets under my control, rises and the transaction fees my broker charges remain fairly static. The discount brokerage market is fairly competitive, so I don’t anticipate a large increase in fees any time soon.

Also, and this is a key point, once I’m done accumulating assets and buying stocks I’ll no longer be paying any management fees at all! This is a discussion point about fees that I see rarely/never brought up. I plan to retire from full-time work by 40 years old and shift from investing in dividend growth stocks to living off my dividends at that time. That means I’ll no longer be paying any fees at all. So, just about the time my portfolio value peaks in terms of market value (and hopefully increases over time), I’ll be paying exactly $0 in management fees.

So, let’s extrapolate this out in the future.

Let’s say it’s 2023 and I have $500,000 in dividend growth stocks. My dividend income at this point completely covers my expenses and I now consider myself financially independent. I stop buying stocks, and shift my attention to writing, spending time with family and friends, volunteering my time, reading and casually checking in on my portfolio to make sure everything is humming along. I’ll be paying $0 in fees if I stick with a dividend growth investing strategy here. I’ll just collect my dividends as they are deposited into my brokerage account. Can’t get much better than that!

Let’s pretend for a moment that instead I had $500,000 invested in VIG. I’ll be paying $650 in annual fees based on the total amount of assets under control. That’s $650 that doesn’t go in my pocket because I want to buy into an index fund that just so happens to own many of the same companies I do. The top 5 holdings of VIG are currently: Wal-Mart Stores, Inc. (WMT), The Coca-Cola Company (KO), The Procter & Gamble Company (PG) and Chevron Corporation (CVX). Hmm, I already own all five.

Next, let’s talk about yield. 

Based on the amount of dividends I’m going to receive over the next 12 months (a little over $3,700) and the total value of my portfolio (currently about $105,000) I have an effective total portfolio yield of about 3.5%. This compares extremely favorably to the 2.17% 12-month yield of VIG. I don’t really think this area needs further extrapolation or explanation. That 1.3% spread in yield is tremendous over time.

What about dividend growth?

Many of the companies I invest in have lengthy histories of dividend growth, often well above the rate of inflation. For instance, my most recent purchase of Air Products & Chemicals (APD) is a good example. Just recently, APD raised the dividend by 10.9%. Wells Fargo & Company (WFC) raised its dividend twice this year, most recently by 20%. Wal-Mart Stores, Inc. (WMT) raised its dividend by 18% earlier this year. I get 100% of the net effect of these raises in my portfolio, as there is no middle-man index fund to take these dividends and disperse them any differently than the company would to me as a direct shareholder.

What about VIG? The distributions of VIG have remained relatively static over the last few years. For instance, their total 2011 distributions were 11.8% larger than the 2010 distributions. That was after a 6.6% raise for 2010 distributions over 2009′s total. While 2012 looked better, at about 20% larger than 2011, this was mainly due to a very large distribution in December of 2012. This was likely due to the large number of companies that decided to pay accelerated dividends in face of the looming fiscal cliff. Looking at current numbers, the distribution of $0.228 in March was not much larger than the distribution of $0.285 back in September of 2011. I’d rather take my chances as a direct shareholder. 

The sale of assets!

One of the most convincing arguments, in my opinion, to invest in individual companies over index funds is the sale of assets. With the strategy I’m engaging in, I look at my portfolio as one big dividend tree. Each branch is a company, and each branch provides bountiful fruit on a monthly, quarterly or semi-annual basis. My plan is to simply pluck that dividend fruit and live off of it once the passive income exceeds my expenses. If I were to slowly sell off assets and live off the capital gains I’d be effectively cutting down my tree one branch at a time until it dies.

Most investors in index funds actually rather plan to sell off assets. The plan is to build a comfortable asset base well into the hundreds of thousands of dollars, or millions of dollars, and sell off 4% of those assets based on the 4% Safe Withdrawal Rate. That means you’re selling off 4% of your wealth every year (sometimes actually increasing this fire sale with the rate of inflation) while hoping that the stock market rises in kind to keep your asset base stable or increasing. The problem with this strategy is that in years where the stock market performs very poorly (think 2008-2010) you’ll not only be selling off your assets to pay basic expenses like rent, food and the electric bill, but you’ll also be losing a large portion of your golden goose as the stock market erases large portions of your wealth. Of course it’s important to be diversified away from just the stock market, but this point remains.

What about Voting rights?

This one is pretty simple. While most common stock infers voting rights, index investing generally does not. This can be a benefit or a drawback depending on your viewpoints. I personally believe that the right to cast my vote on certain company matters is important and one I like to reserve.

Which one offers more control?

Another easy one. As an individual dividend growth investor that focuses on high quality companies at attractive long-term prices, I can fully 100% control what companies I own, when and at what price. With an index fund, I have no say over that.

Conclusion.

While there are certain aspects of index investing that are attractive, like the completely passive nature of it, I find that for an engaged and educated investor the better path to wealth accumulation would be to focus on direct partial equity ownership in high quality companies that have a lengthy history of paying, and raising, dividends.

Again, I would stress that many people don’t have the interest or time to educate themselves about finance and investing to the point where a dividend growth strategy makes sense. In these cases, index investing (even factoring in the shortcomings) would be the better investment vehicle. I personally quite enjoy reading stock analysis reports and looking at income statements, cash flow statements, balance sheets, annual reports and the like. I find investing to be a wonderful hobby that I’ll take an even more active interest in once I’m free from the shackles of full-time employment.

What do you think? Are you a fan of index investing? 

Full Disclosure: Long WMT, KO, CVX, APD, PG, PEP, WFC

Thanks for reading.

Info for VIG pulled from Morningstar.

Photo Credit: pat138241/FreeDigitalPhotos.net

Comments

  1. says

    Wow DM, couldn’t have spelled it out better myself! Currently, I plan on a very similar dividend growth model to augment my other passive income sources and replace my income needs. At the end of the day, I don’t intend on drawing down any investments to fund my retirement. Build the nut, then protect the nut.

    • says

      writing2reality,

      “Build the nut, then protect the nut.”

      Amen, brother.

      I’m glad you enjoyed the article. Keep up the great work, and keep building that passive income. The you of 10 years from now will be glad the you of today had such foresight.

      Best wishes!

  2. says

    I ended up with a dividend investment portfolio mainly because I wanted a value “anchor” during the withdrawal phase. I wanted a transparent portfolio where I knew that my cash flow was predictable regardless of market fluctuations. Of course, there is always the risk of dividend cuts. But that is not the same kind of risk as market risk. The former occurs slowly and I can analyze things and deal with it at my leisure. The latter occurs violently and often without warning, and that is not something I want to worry about in my retirement years. I want to be able to say “my portfolio will return X amount this year for living expenses”, regardless of whether the market goes up 15% or down 50%.

    • says

      S.B.

      Well, that’s one of the many great things about dividends. They somewhat isolate you from the upward and downward swings of the market. A great majority of many of the commonly held dividend growth stocks maintained their dividend streaks right through the Great Recession. So, while their share prices declined steeply with the broad market, an investor that held through would have kept receiving their dividends and raises like nothing had happened. This is a wonderful feeling if you focus on the passive income and not the underlying equity prices. In the end, I look at it as I’m a part-owner in a business. The value goes up and down, and that doesn’t really matter. Just as long as the business continues to pay me a chunk of profits.

      It would be akin to checking the value of your house everyday and then trying to move based on the local real estate market and the price of your home. To me, that’s equally as crazy.

      Best regards.

  3. Spoonman says

    A basket of dividend stalwarts is one of the best ways to build an income stream that monotonically increases over time. That’s why I fell in love with dividend growth stocks.

    I am in a great situation with my brokerage (Wells Fargo). I can make 100 trades per year without charge. How much have I paid in fees since starting my journey in 2010? $0. You need at least 25K in assets in order to get the service for free. That’s about an $700 value per year.

    • says

      Spoonman,

      Thanks for stopping by! Enjoying reading about your journey towards early retirement. A wonderful journey, no?

      Great situation there with Wells Fargo! I’d love to have something like that. Although my fees are relatively small now, $0 would be much better!

      Keep up the great work, and I’ll look into the Wells Fargo program.

      Take care!

    • says

      You’ll probably want two or three brokerage accounts to spread your $500k+ final number around, so you don’t have to worry about the one company failing.

      Besides Wells Fargo, TradeKing and Optionshouse, have lower transaction costs than Scottrade.

    • says

      me myself and I,

      This is something I’ve thought about. It’s pure laziness that has kept me from already opening a second brokerage account. I have to get this done at some point, because eventually the amount I have invested will grow to $500k or so all by itself. Better to reduce risk in terms of brokerage failure.

      I’ll have to look at Wells Fargo. I’m already invested in the company, so it would make sense to use them as a service as well.

      Best wishes.

    • says

      How does a brokerage failing effect owners of stocks? If my brokerage (eg, scottrade) fails, then wouldn’t I still be an owner of the stocks in this company? Or are you saying some sort of illicit activity like a brokerage selling your stocks for capital is the real risk we’re talking about (Isn’t that what Joe Corzine did with his investor’s money?)

  4. Anonymous says

    Awesome article. I’m an index investor who would probably be a dividend growth investor if I believed more in my ability to take advantage of market inefficiencies. This article pointed out a few advantages I hadn’t fully quantified before.

    One correction about index investors following the 4% rule is that it isn’t their intention to sell 4% of their assets each year. Don’t forget that these stocks still have a fairly decent dividend rate – something like 2.5%. That would lead to the need to only sell off 1.5% of assets, which is well below average growth and would still lead to an increasing dividend payout. My goal is actually a 3% withdraw rate which will have me selling off only a tiny portion of assets.

    I’m not sure I fully trust the idea that dividends are slower to be reduced during bad economic times. They might not be reduced right away, but during the recent recession, many companies once they reduced the dividends, cut them in half or more.

    I would love to see a comparison article sometime between how you’re doing and how you would have done if you had invested your money into VIG or VTSAX at the time of each of your buys. Also, since you are retiring at 40 and will need access to much of your money outside Tax Advantaged Accounts, have you accounted for the difference in compounding since you will be paying taxes on the larger dividend payments while index investors can hide their capital gains from taxes until the point of sale? This is one reason why I’d sometimes prefer companies to do share buybacks over dividends.

    • says

      That is a very good point. In my research, I have uncovered that when the four percent rule was invented in early 1990′s, the dividend yields on stocks were around 4%. This is why I think that the strategy was successful in the first place – it essentially relied on cash from dividends ( and interest income,which was much higher also). Dividends are also much less volatile than cap gains, which is why they are more reliable: http://www.dividendgrowthinvestor.com/2013/04/the-four-percent-rule-is-dependent-on.html

      I do not like funds for same reason as D Mantra. While my own portfolio will have turnover over the next 40 – 50 years, it would not result in a turnover rate equal to a 0.13% annual fee.

      The issue with dividend ETFs is that they weight stocks based on yields or capitalization, not equally, which is what dividend investor do. Dividend etf’s also maintain stocks that don’t even pay or have substantially reduced dividends for long periods of time – check what happened in 2008 – 2009.

      In addition, not all dividend stocks in an ETF are buys. That is why an individual income investor can maintain a better dividend income. Also, dividend investors do not re-balance every year.

    • says

      Anonymous,

      Good point there on still being able to receive the underlying yield on the index fund. However, selling assets off is still a reality for most. For instance, I used $17,500 as “my number” of passive income in the examples above. That would require $500k invested at a 3.5% yield. In VIG, however, that would require over $800,000 in invested assets. That’s a full $300,000 spread. I don’t know if people really are aware how much of a difference that is. So, you’re either selling assets to bridge that gap or you’re investing much longer. I’m against selling assets, so I’d have to come up with an extra $300k, which would lengthen my journey to financial independence quite a bit. That’s a big downside, in my opinion.

      “I’m not sure I fully trust the idea that dividends are slower to be reduced during bad economic times. They might not be reduced right away, but during the recent recession, many companies once they reduced the dividends, cut them in half or more.”

      I’m currently invested in 31 companies. As far as I’m aware, 1 cut the dividend (WFC), 2 held the payout static (TD, BNS), and 1 is a new entity (PSX). I’ll take those odds.

      Best regards.

    • says

      DGI,

      Thanks for stopping by! I figured you might have an interesting take on this.

      “I do not like funds for same reason as D Mantra. While my own portfolio will have turnover over the next 40 – 50 years, it would not result in a turnover rate equal to a 0.13% annual fee.”

      Great points there. I was being a bit tongue-in-cheek with the $0 fees going forward, but I don’t think it was too far off-base. I’ve only sold 6 times since I started this blog 2 years ago, and I don’t anticipate keeping that average (3 per year) going forward. I’m still learning, and a couple buys were not good ideas (TEF) and at least one sale was regrettable (XOM). I’m not perfect, but I hope that within 10 years time I build a portfolio that is fairly sustainable over the long-term.

      “In addition, not all dividend stocks in an ETF are buys. That is why an individual income investor can maintain a better dividend income. Also, dividend investors do not re-balance every year.”

      Another good point. I’d rather selectively purchase stocks based on individual merits than to let someone else do it for me, without my control. Some people prefer to have someone else do it for them. This is just an individual choice based on personal preference. And yes, again rebalancing a fairly sustainable portfolio of 40 or so major companies is likely to be minimal, and certainly much less than 0.13% of assets.

      Best wishes!

  5. says

    This sums up a lot of my reasons for avoiding index funds.

    The other thing that I like about my dividend growth portfolio, is that I know exactly when I’m financially independent. Once the dividends match my expenses, FI achieved. With index funds, I have to decide whether I want to use a 4% or 3% withdrawal rate, and then hope that we don’t have a market correction.

    Most of the companies that I own paid dividends throughout the Great Recession, even though their share value fell. This means that dividends are a bit of a hedge against recessions as well.

    • says

      MFIJ,

      Absolutely. The selling of assets is almost a necessity with index funds based on how they are set up, unless, of course, you can live off a much smaller yield than a diversified well-planned dividend growth portfolio would otherwise yield. Plus, when you have control you can increase or decrease your portfolio’s yield at will. An index will yield what it yields, and you can do little about that.

      Take care!

  6. says

    You make a great point about the time needed to be a well educated dividend growth investor positioned for success. I agree, its worthwhile and we are all looking forward to seeing your dividend income reports when your portfolio reaches that $500k level.

    • says

      Dividend Ladder,

      Thanks! I’m definitely looking forward to my dividend income reports when my portfolio reaches that level as well! We’ll see how it goes. I’m blessed just to have made it this far.

      Take care.

  7. Anonymous says

    I understand your reasoning and appreciate why you feel the way you do, but I still think index fund investing (particularly with dividend-focused index funds like VIG, SDY, etc.) is a very good choice for a lot of investors.

    First, your point on fees is somewhat flawed. You write that you won’t have any fees in the future from transactions — while I suppose that COULD be true, it’s highly unlikely to BE true. Surely you’ll periodically rebalance your portfolio, switch out of stocks of companies that fail/stop paying/reduce their dividends, etc. It stands to reason that some of if not many of the companies you’re currently invested in will at some point fail, or be acquired by someone else who doesn’t want to pay dividends, etc….particularly when you factor in the length of time you’ll be “retired.” Don’t believe me? Check out the components of the Dow 40 years ago to see how much it’s changed in 40 years (roughly the time period from your retirement at 40 until you’re 80). I’d call the fees issue a wash, if not slightly tilted towards the index fund (since they’re rebalancing without you having to exert any effort).

    Diversification is also ignored in this analysis. I see your holdings are pretty well-diversified, but that requires you to actively manage your funds and track dozens of funds, and will require that you continue to do this into the future as the economy expands in ways and directions we cannot even imagine. VIG? It self diversifies (and rebalances) by itself, with no effort on my part.

    I think the sale of assets point is also false. I may get dividends 4 times a year, but if I budget properly I can make that work just as well as you do, without selling any assets.

    Again, I respect what you’re doing, and it seems to be working for you. And the article is entitled “Why I (emphasis) Vastly Prefer Dividend Growth Investing to Index Investing”, so you’re entitled to your opinion. But in terms of ease of investing, diversification, re-balancing, etc., many investors have valid reasons for preferring index dividend-focused investing, and can probably do quite well at it.

    (I’ll also echo the suggestions above — I’d love to see a study on how you’ve done versus how you would have done if you had invested in VIG or something similar over the course of your investing career thus far….)

    • says

      I agree, but to add to these points, you’re leaving out potentially the most important reason why indexing is far superior to individual stock picking: no one can predict the future.

      Let’s say, hypothetically, you own 30 holdings. If one of these companies goes out of business — as unlikely as it may seem, this is a perfectly legitimate concern — a bigger portion of your portfolio takes a hit than if you were invested in index funds.

      With SDY, for example, the yield is lower than Mantra’s overall yield average of 3.5%, but if 8% of your portfolio takes a hit when one of the companies files for bankruptcy, this may have a much more profound effect on long term wealth accumulation than the lower dividend yield from the index fund. It’s bound to happen sometime which is why diversification is paramount.

      If JNJ were to go bankrupt — again, unlikely but possible based on history — Mantra would lose nearly 8% of his portfolio, while if he were invested in SDY he would only take a 1.8% hit. If you believe JNJ is sound and will never go under, feel free to use this example with the 29 other holdings.

      Everyone is individual and no one strategy is inherently right for everyone; however, the main benefit of an index generally lies in the fact that it’s more diversified (for example SDY has 86 holdings) than an individual’s portfolio.

    • says

      Anonymous,

      Fair points there. Again, I would like to reiterate that I believe index investing is best for the vast majority of investors out there. I mentioned that a couple times, and I think it bears repeating. I’m biased, as you can tell, but that doesn’t mean I’m opposed to logic. I can see how a lot of people are averse to the time it requires to learn how to invest for themselves. I would argue that once that fundamental knowledge is in place, however, that the time is greatly reduced on an ongoing basis.

      “I’d call the fees issue a wash, if not slightly tilted towards the index fund (since they’re rebalancing without you having to exert any effort).”

      I’d strongly disagree with you on that, however. I think I laid out a clear and concise example of how fees are definitely not even close to a wash. Again, as I mentioned in a comment above, I wasn’t totally correct with $0 in fees going forward forever. There is likely to be some turnover, but I’d definitely argue it would be nowhere near $700 per month and climbing. I’ve sold 6 stocks since I started this blog 2 years ago, and I anticipate that rate declining as I cement my portfolio and as the weightings start to even out. The odds of me making 100 transactions per year on a 40+ position portfolio in retirement is highly unlikely just simply based on my habits.

      Again, I’m not trying to talk anyone out of index investing. I think it’s a fantastic wealth generator for many. I would also say that investing in itself is wonderful. I encourage everyone to invest if they can. I simply laid out my case for why I personally believe dividend growth investing can be superior if one is so inclined to be educated.

      Best wishes.

    • says

      Pey,

      I think you are being pretty selective with your numbers there.

      You picked out JNJ in your example, which just so happens to be my second biggest position, and probably one of the most unlikely companies to go out of business.

      “If you believe JNJ is sound and will never go under, feel free to use this example with the 29 other holdings.”

      Okay, let’s play that game:

      Let’s take SBSI. That’s a small cap bank that would much more likely go under than JNJ. If SBSI goes bankrupt it would have an effect of -1.3% on my portfolio. That’s a lot closer to the numbers you’re using.

      Also, my portfolio is 1/5 complete, or somewhere about there. I’m still building it. It’s changing over time and the weightings will be more evenly spread as I continue to inject more funds. I’m buying what I feel is most attractive right now with less of a thought on certain stocks becoming overweight in the portfolio, because I know that I’m going to be investing a lot more capital over the years and will have a chance to “catch up” other positions. So, picking out one of my biggest positions in a portfolio that is only 20% complete and comparing it to an index fund is a bit misleading.

      Also, typically when most companies go bankrupt it isn’t overnight. It’s a slow, decline in business that eventually leads to a restructuring, sale or bankruptcy. It isn’t like, oh my – JNJ is bankrupt. It’s a bit different than that.

      Hope all is well!

      Best regards.

  8. says

    Nice piece on the today show. And congratulations on your portfolio achievements. Last year I started my own dividend growth investing, outside of what my financial adviser does for me, and just recently stumbled across this blog through seeking alpha. I’ve since started following your blog and a similar one because I find saving and investing fascinating. One could argue either way as to what is better, investing personally and choosing your own funds or deciding to go with index funds. I imagine like an architect or builder following their project to completion you feel the same rush and excitement they do every time you monitor your positions. Can one even put a price on that? You may have mentioned this earlier and I will try to find it but what do you use to track your positions excel, google documents? Enjoy your weather down there. The midwest has been taking a spring beating lately.

    • says

      RXSKI,

      Thanks for stopping by! Glad you found me via the spot on TV. :)

      That’s a great analogy with the architect. I would agree with that. I think that this strategy requires interest. If you’re not interested in what companies do, how they do it, reading annual reports, and if you don’t have a general interest in business itself than index investing is probably going to serve you much better. I do rather get quite a bit of enjoyment out of researching companies and buying a piece of a business. It’s fun. The fact that this strategy, in my opinion, is superior to index investing just makes it that much better.

      Sorry to hear about the weather! I was just in Michigan at the end of March and it was really beautiful. Gotta love that midwest weather. Never know what you’re doing to get.

      Please stay in touch and good luck with building your portfolio!

      Best wishes!

  9. says

    You certainly made your case. I think I’m going to have to stick to index funds for the time being for exactly the reason you suggested: time. But after reading this, I think I will start planning to shift away from this and take a little more control back for myself.

    • says

      Pretired Nick,

      Glad this article gave you some food for thought. Again, if index investing is serving you well there is probably no need to change. I simply offer my personal take from this side of the fence.

      Good luck either way! The fact that you’re investing at all is what’s important.

      Take care!

    • Debbie M says

      I was using just index funds (with 10% in each of these: large-cap US growth, large-cap US value, small-cap US growth, small-cap US value, European, Asian, emerging, REITs, and bonds plus getting I-bonds on the side). Now I’ve switched to from two large-cap funds to one and am working to have the same amount in dividend-growth stocks on the side. I noticed that some of my dividend-growth stocks are classified as growth and some as value (which surprised me–I expected them to be mostly value), so that’s why my other large-cap money is in a general index fund.

      I’m only 2 – 4 years from my pension; you may have time to make a much bigger switchover. I do like the diversity of having more sectors because I don’t trust that I would pick better-than-average stocks or that dividends won’t shrink even more in the coming decades.

      Once I start needing that money, my plan is that if the amount I have is more than it would have been with straight 8% growth, I’ll calculate the 4% based on the amount I would have had if my money had grown only at a rate of 8% per year. That should keep me from taking too much at the beginning if there’s a big bubble.

      If I have less than I would have had with 4% growth, I’ll start with 4% of the amount I actually have. That should keep me from taking too much of an already flattened portfolio.

      Then each year, I’ll calculate the inflation adjusted amount and also 4% of my current amount and withdraw the lower of those two amounts. These strategies should make it to where there is very little risk of taking out too much, so I’m not too worried about chopping off the tree limbs. However, if I’m wrong about that, it’s not a big deal for me because the majority of my income will be coming from a pension.

    • Debbie M says

      Oy, now I see a couple of typos! But I’m glad to expand my strategy to include a bit of yours. Thanks for writing!

  10. Anonymous says

    Why not start investing via DSPP from Computershare? Some companies offer no cost to buy, but you are limited with regards to purchase and sell price.

  11. Chad says

    Great article. Many of the same reasons that I also dividend growth invest over index investing. One reason that you didn’t cover is the choice of investments. My wife hates Monsanto with a passion. It’s why our portfolio will never have it. Can’t do that when you index invest. Also works for the people that don’t want to invest in cigarettes or gun companies.

    Don’t get me wrong, I think index investing is great. My bond portion of my portfolio is indexed. And if you don’t want to track your investments, you should index invest your portfolio.

    • says

      Chad,

      I’m glad you’re a fan of this strategy as well. While index investing is wonderful for most, I simply think this strategy is superior if you’re interested in actively managing your portfolio.

      I did actually cover the choice of investments in the second to last point. It was listed under “Which one offers more control?”. I do believe that being able to invest in companies you like at prices you think are attractive is a wonderful freedom that index investing does not offer. There are many companies that I would greatly prefer to not invest in at all, and it’s tough to find an index fund where you’re 100% happy with every position.

      Best wishes!

    • Debbie M says

      It’s true that buying the stock increases demand and thus raises the price for those who are selling, which probably includes the people who run the company, so I can see why you’d want to stay away.

      But one advantage of owning Monsanto (as an individual stock rather than as part of a fund) is that you get to vote. I’m not sure what all they let stockholders vote on, but the notion intrigues me.

      You would also be in a win-win situation. If the stock goes up, you get some of the money. If the company becomes worth less, that’s good news, too.

  12. says

    DM,
    I agree with your position regarding DGI vs. Index but I will bet that you will still be incurring trading fees after retirement  (It’s just too hard to sit on the sidelines).
    Also I don’t think that all index funds pass on all of the company’s dividend increases.

    DF

    • says

      Dividend farmer,

      I agree with you on that. I should have probably worded that differently, but I doubt I’ll be incurring more than $60 per year in transaction costs when I’m done accumulating assets. That’s about 90% less in fees vs. VIG.

      As far as the dividend increases, it certainly looks that way. I wouldn’t be very happy to invest in VIG with such a low yield and a rather subpar dividend growth history. Just not for me, especially when they own a lot of companies I already own and can buy when I want.

      Best regards.

  13. says

    Besides their fees, another reason I prefer investing in individual DGI stocks over ETFs is that many of the dividend ETFs neglect the G part. The dividends they pay out tend to fluctuate quarter to quarter if they even pay out at all.

    Take the SDY, PFM, & PID ETFs for example; In early 2009 none of them paid any dividends for at least one quarter. An entire quarter with no payments is inexcusable. I doubt they waived their expense fees either.

    The reason most of them didn’t pay? They were all over-allocated towards financial stocks. I think SDY had almost 40% of their holdings in TBTF banks. So much for the diversification argument.

    Btw, congrats on the Today show appearance DM. You did a great job representing us.

    • says

      wes mantooth,

      Hey, thanks for the nice words. I’m glad you enjoyed the Today appearance. They condensed about 3 hours of material down to 5 minutes, but I think they included some nice footage, especially with my last quote on buying time. That was nice.

      I’m with you on the fluctuations. One of the things I love most about dividend growth investing, is that for most companies (especially American ones) you can count on what you’re going to receive down to the penny and on what date. It’s like clockwork. Which is nice, because bills for living expenses are also clockwork in their recurrence.

      Best wishes!

  14. says

    Dividend Mantra,

    Great article and I agree with you that it is better to hold individual securities rather than a dividend growth ETF. I like having complete control over the companies I own and also the price I pay for them. Having said that, I think these index funds are a great option for those that do not wish to research individual companies.

    Another point to consider is that the .13% annual fee for the VIG fund you mentioned above is ongoing based on the principle amount of your portfolio. In addition, you still will incur transaction costs from your broker on top of this for acquiring new shares. By owning individual companies, you will only incur transaction costs for new shares purchased. Once purchased, there is no ongoing fees on existing shares.

    Thanks again.

    • says

      Dividend Freedom,

      Great name! I like that.

      Great points on the fees. The fees are based on the principle amount of the portfolio, or total assets under control of the fund. And yes, buying additional shares also include fees, usually. I think that dividend growth investing is one of the cheapest possible ways to invest in terms of the fees/transaction costs paid. Index funds are certainly much cheaper than many mutual funds, but that’s comparing a slightly pricey fee structure to one that’s astronomical. Not exactly a win-win.

      Best regards!

  15. Larry says

    Great point about the fees, personally my broker has $10 commissions on trades so I never trade less than $1000 so I limit the transaction costs to 1% or so. Darn fees !

    • says

      Larry,

      Absolutely. It would make no sense to engage in a dividend growth strategy and buy individual companies to then sink your own ship by buying stocks in such small amounts to where the fees eat up your returns. I try to make sure every transaction is at least $1,400, and more when possible.

      Darn fees is right! :)

      Best wishes.

  16. says

    Nice post, DM. To take your dividend tree analogy a step further: If a stock is no longer effectively contributing to your investing goals, then you can selectively cut that branch off the tree and graft on a new branch representing a better alternative. You can also be selective about which branches need pruning (selling off shares of an overvalued stock) or strengthening (buying shares of an undervalued stock). You cannot do any of those things with an index fund.

    I agree with all the points in your post, which is why I don’t have any index funds in my dividend growth portfolio. However, I will soon have no choice but to own some index funds among my total investments. I’ll be participating in two retirement plans with my new employer and the investment options are limited to target-date funds, a few managed funds (no thanks), and a handful of index funds. I’ll likely allocate contributions to a combination of two or three index funds, but that’s something I won’t need to deal with for a few months.

    • says

      DGM,

      Absolutely! That goes back to one of my last points about control. I could have expounded upon that point a bit further, but I felt the article was getting a little verbose. If a company starts to make choices that you don’t agree with, or fundamentals change/deteriorate then you have a choice as a shareholder to part ways. With an index fund you have to wait until the fund manager to make that choice, if they ever do it at all (depends on the fund).

      Yes, unfortunately many retirement plans only have fund options. At that point, you can only make the most of that situation by picking the low-fee index funds that align well with your overall investment strategy.

      Best regards!

    • says

      Hey Jason

      I love this post, it really made me think.

      Here are a few thoughts from the little dialogue in my head:

      Pro DGI:
      On the control side, the index fund can generate capital gains that would be taxable events even without liquidating any shares. Most often this happens as the indexes change and the funds need to adapt to the new index. +1 for DGI for Control

      Yield is higher, requiring less initial capital to retire. You mentioned this in response to an earlier comment: 500k at 3.5% throws off the same dividends as $800k in VIG. That’s a big incentive for DGI (understatement of the year :D) +1

      Needing to sell in a bear market is bad news. It would have royally sucked to need cash in late 2008 and need to sell stock, for example

      Pro Index:
      Those internal index fund sales could also be losses, generating tax advantages. Generally though for spending at our levels, the tax is $0 on these small amounts

      Most often recommendations for index investing are for VTI. It pays an SEC yield of 1.97% vs VIG’s 2.11% but has a 0.05% expense ratio vs 0.13%. On 500k, that’s roughly $250 a year in VTI, having only a delta of $50 a year compared to your $200 estimate. Still, its more than $0. (This is where most of our $ is, but we had more money than sense when learning about investing :P)

      The DGI stocks are often large blue-cap stocks with lower growth rates than small-caps and mid-caps. Large blue-caps throw off a large dividend partly because re-investing it in the company isn’t going to make it grow any faster. An extra billion dollars for coke won’t make them sell any more of it, for example. With an index fund, you have a lot of small and mid cap stocks in the mix, so it is possible that the overall capital growth of the index option will be higher. If it is, then this could provide better long term wealth, making it easier to get your name on a nice Ivy League University building

      If I were in your position today, I would be going the DGI route

      Thanks for the mental exercise

      Jeremy

    • says

      Jeremy,

      Great comment there. I think you made a fair case for the pros and cons to both sides of the coin.

      I don’t think either strategy is “right”, but rather you should be picking the correct strategy for your individual temperament, goals, time, interest and the like.

      I do believe dividend growth investing can be a superior strategy overall (when factoring in the fees and additional income), but requires more involvement and interest, so the offset can be quite dramatic if you don’t find yourself actively excited to research individual companies and the like.

      Thanks again for stopping by and offering that perspective. I think the index investing route is more appropriate for the majority of investors, but for those interested parties in taking a more active approach to their passive income generation, dividend growth investing can squeeze more growing income out of a smaller source of capital.

      Best wishes!

  17. says

    Good post about index investing.
    I only see by dividend investing, since Dividend Ninja shown me the right path and prevent me to lost a bunch of $.
    Dividend investing doesn’t care about the market, only the valuation of the company is important.

    Cheers

    • says

      JF Baconnet,

      Glad to see Ninja put you on the right path, and you find yourself now enlightened! :)

      Keep down the path and I’m sure you’ll find yourself amply rewarded.

      Best wishes!

  18. says

    This might be a bit off topic, but I noticed the various points on brokerages and had a question. I invest through Compputershare. Is that better or worse than Scottrade, etc? I pick companies that only incur one-time fees, but I may notbe getting the best deal. Thoughts?

    • says

      Dan Smith,

      I really can’t say anything about Computershare as I have no personal experience with them. They don’t appear to be a discount brokerage from first look, but seem to be more of a full service broker? Is that correct?

      I use Scottrade because the transaction costs are small at $7, and they have plenty of physical locations that I can visit during normal business hours and actually talk to someone. I like that. They are more for a DIY investor, but they do offer advanced services for those so inclined. They do actually also offer a lot of free seminars around the country which seem really interesting. There’s definitely some value there.

      Sorry I couldn’t be of more assistance.

      Best regards.

    • says

      No worries! Thanks for your thoughts. Computershare is the transfer agent for a lot of companies and do DSPP and DRIPs for them. You’ve really got me interested in buying through Scottrade because Computershare has a higher fee (probably to make you keep the shares longer, not sure). Anyway, love your blog!

  19. Anonymous says

    This sounds really fascinating and perhaps I might start to invest this way. I am kind of worried about the tax impact though. If I wanted to save enough in dividend stocks to retire early, I’d would surely experience greater taxation, perhaps enough to offset the benefit of no ongoing fees. Or am I missing something?

    • says

      Anonymous,

      Taxation is really a totally separate subject. You will be taxed on dividends by way of direct equity ownership or index shares if you have your investments in a taxable account. Having either of these investments in a tax advantaged account (IRA, 401(k)) will avoid taxes, at least until withdrawal of funds (unless it’s a ROTH IRA).

      However, I have 100% of my investments in a taxable account because I want to access my funds very early in life. I also would rather avoid trying to find loopholes (SEPP) to try and access money from an IRA early. Certainly one can spend the time to invest some of their money in a tax advantaged account and then try to access it early in life (one can take contributions out early), but I keep in mind that dividends are inherently tax-friendly (0% taxes up to the 25% tax bracket on qualified dividends) and I’ll also be exposed to taxes for a short period of my life. By the time I’m actually earning serious dividends ($15k+ annually) I’ll be either close to retired or actually retired.

      Best wishes!

  20. Anonymous says

    That your portfolio will be worth about 5 times its present value in 10 years is possible, but still somewhat presumptious.

    • says

      Anonymous,

      Well, we’ll see. This blog will keep me honest all the way along. I think a lot depends on my ability to continue earning what I do, and hence saving/investing what I do. If I’m able to continue socking away ~$2,500/mo then I think my goals are realistic. Of course, if I aim for the stars and land on the moon I’ll still be ecstatic.

      Best regards.

    • Anonymous says

      $30,000 a year! Well at that rate of saving I would expect you will far exceed $500,000 in 10 years. For some reason I assumed your contributions to your portfolio where far less than that. Okay, with that kind of money to invest I agree your strategy is sound, and even if you hit a bump in the road you should still have enough assets to recover and have a comfortable retirement. Especially if you keep on top of your portfolio review as you said you enjoy and are knolegable to do competently. For most people, though, who don’t have those kind of assets to invest, they would likely have to engage in at least a partial canniballiasation of their portfolio over the years and a later retirement age.

  21. says

    Hello Everyone,
    I am new to this field of personal finances, so i need some help. I am new to investing and so far i have learned that i dont know enough to choose my own stocks and put them together in one fund. So next best i thing is index funds. At that point i ran into this article. It’s a good article and makes me re think my strategy.

    What i would like know is the meaning of “Dividend Growth Investment”. Does it mean simply buy stocks which offer higher dividend? Or is this a specific type of mutual fund? Also, i have only a small amount contributed to Traditional IRA. And as many of you have said, it is not accessible prior to certain point in time. However, that small amount is still sitting in IRA which i would like to get best use of.

    Can someone suggest me what i need to look at or point me in some direction where i can better manage my personal investments?

    Thanks in advance

  22. Anonymous says

    I’ve employed a bit of a mixed strategy. I try to get close to maxing out my 401k, and all of that is in various funds, ETFs, and the like. On the other hand, the objective of my stock portfolio in my brokerage account is to be a dividend earning portfolio. This way, by the time I retire, likely much sooner, dividends will be a solid part of my net worth and annual income but I’ll also have solid exposure to international markets and growth-type investments.

    It sure makes buying stocks easier when I’m focused on ones that provide future income opportunities, since there are way too many to evaluate for their growth prospects.

    • says

      Anonymous,

      Sounds like a great strategy there. Nothing wrong at all with diversifying between investment vehicles, and index investing is a great way to build wealth for very little time commitment and low fees.

      And I agree with you that focusing on dividend growth stocks makes picking individual companies easier. It limits your available universe of investments, bringing down the available list of companies you can invest in from the thousands into the hundreds. Makes things a bit easier. :)

      Best wishes.

  23. Anonymous says

    It probably should be pointed out that index investing was originally meant as an argument against actively managed funds. I believe it was Bogle who argued that index funds typically would outperform all actively managed funds over a sufficient long period, in part due to the lower fees and lower amount of churn. Ultimately, I think index investing has many similarities to buy and hold DGI (after all, an index is pretty much a relatively arbitrary selection of stocks based on a given criteria).

    I think the only thing you might want to watch out for as a DGI investor is to make sure you’re not too concentrated in any one stock or sector.

    • says

      Anonymous,

      I agree with you that a potential drawback to the dividend growth investing strategy is being over-concentrated in one particular sector or stock. As is, I’m exhibiting that problem with my very heavy allocation to JNJ and PM. I’m hoping that over time these weightings become more even as my portfolio grows in around some of my larger positions and I invest more in my smaller holdings.

      However, you see this with many index funds that can be heavily allocated to Apple, Exxon Mobil and some other mega caps. Obviously, this isn’t as big of a problem with there are hundreds of holdings in the fund.

      Thanks for stopping by!

      Cheers.

  24. Grey says

    i am learning myself and have only actively involved for the last 5-7 years heavily in investing with each year steadily increasing. I am also teaching my children, ages 13 and 15 about dividend growth and how it can pay them steadily and grow while they sleep (literally and figuratively) and have had each invest half of their hard earned money into some companies already for this very benefit. I WISH my husband or I had had the same education when we were their ages!

    • says

      Grey,

      Congratulations for not only taking control of your finances, but teaching your children some solid financial principles as well. Good for you!

      I wish you, your husband, and your children nothing but the best. Keep at it. Success begets success.

      Take care!

  25. Ryan Torville says

    How will you live on 3.5% interest of $500k? That’s only $17,500 per year–below the poverty level.

    • says

      Ryan,

      $17,500 is plenty for someone who prefers to live frugally, like myself. That’s around $1,500/month, which if you look through my historic budgets I’ve been able to live on less than that for quite a while. My budget is inflated right now due to the amortization of a car, but if I were FI I might not need a car again. Furthermore, the amortization ends in a few months and my expenses will be low again. Additionally, once I own all of my time I’ll likely have many opportunities to increase my income if need be.

      Cheers!

  26. says

    Jason…I am a new reader of your blog and I must say…I am very impressed. Thanks for sharing your journey with us and your background as well. I am coming from a bit of a different veiwpoint in that I have been retired for over 20 years, now at age of 77, and loving the freedom that this time of life provides. As regards to the stock market, however, I must say that I totally blew it. I traded from the very first dollar I saved and made money fast and furious and lost money even faster and more furious. In the end I lost over $100,000 during my 30 years of ups and downs in the market.

    Now with more patience and understanding, I wished I had only purchased dividend paying stocks as you are, and held them forever. “Coulda, woulda, shoulda.” I’d say you are absolutely on the right path. After reading your blog, I decided this time to do it right and started to invest slowly using a L3 account with top dividend paying stocks which will benefit our grandchildren. Never too late, although the secret of course, is in the compounding of one’s assets.

    • says

      David,

      It’s definitely never too late to start, and your grandchildren will certainly appreciate your efforts. :)

      And thanks for the support. I’m glad you found my humble little spot on the internet and like what you’ve read so far. I hope you stay in touch, and I wish you the best of luck with building your portfolio back up. The good news is that you’ve learned from your past mistakes, and that puts you light years ahead of most people who repeat the same mistakes over and over again.

      Best regards!

  27. Ben says

    I really like the way you look at this. However, you might (and no one can say that for sure) have a underperforming portfolio though because you miss out small caps.

    But I think I’d totally do it like you (except for adding a small cap ETF) if I lived in the US. Since I don’t it would be a real pain to manage the dividend payments of foreign companies and taxes.

    • says

      Ben,

      It’s quite possible I may miss out on some additional upside, but I’m also limiting risk. Most of the companies I own a stake in are relatively stable and have low betas, so they oscillate less than the broader market. I sleep like a baby. :)

      I think when people look at potential return they sometimes forget about potential loss. Managing risk is something I spend a great deal of time on, and probably more so than thinking about returns. Every 20% loss requires a 25% gain just to break even.

      But I do have some exposure to to this space. TIS is a good example.

      Best regards.

  28. says

    phew ! so much helpful information. I like david rodericks comment theres nothing like been there done it experience. his contribution is very beneficial to us all. im weighing up all the pros and cons of DGI and trackers . I think the answer will come to me sooner or later. or I might be a bit of both as i am at present!
    brilliant site even though im from uk ill keep checking in with you
    Div Mantra is inspirational
    I must say having no kids to bring up WILL make you rich!
    Dawn

    • says

      Dawn,

      No kids will definitely speed things along for me, no doubt about it. I decided long ago to not have children, but the financial side works out pretty well.

      I wish you the best with your journey. I’d definitely do a lot of reading and figure out what works best for you. There is no right answer; just what is best for your situation.

      Cheers!

  29. Chris says

    I’ve been reading your site for awhile now and I especially enjoyed this article. At this point I’m more of an index investor, but I really enjoy living vicariously through your portfolio! Aside from my retirement accounts, which are diversified in a reasonable way for my age (36), I also have a taxable account that I am using to get me to an early retirement at about age 50. Right now that account is invested 70/30 in Vanguard High Yield Fund (VYM) and Total International (VXUS). Both yield about 3% and VYM has a pretty good track record of dividend growth since inception. It looks like 13 of it’s top 20 holdings are in your portfolio, so that makes me feel pretty good about it!

    While I do hold some individual stocks in an IRA, I made the decision a couple years ago to move mainly to index funds because I just found myself getting a little too emotionally involved in my portfolio. I would kick myself for not buying at a certain time and missing an opportunity, or fret about a stock dropping a couple points the week after I bought it. I know how silly that is given a roughly 20 year time horizon, but I still let it cause me more anxiety than it should have. Building positions in a couple index funds has removed this stress for me. I also enjoy having my dividends automatically reinvested and look forward to getting my “free shares” every quarter. I don’t disagree with anything in this article and at some point I may move to a portfolio of individual dividend growth stocks myself. But for now I’ll keep building up my positions in VYM and VXUS and enjoy following what you do with the Freedom Fund. Best of luck and thanks for all the great articles!

    • says

      Chris,

      You bring up a great point there.

      Emotions are definitely a big factor here. If owning individual stocks causes you any anxiety at all, then it probably just doesn’t make sense to own them. Forget about beating the market, dividend growth, not beating the market, whatever. If you’re worrying about things, it’s better just to automate your finances to the greatest degree possible, and investing in index funds allow you to do that.

      I personally have never suffered from such emotional swings, because I know deep down inside owning index funds is basically the same as owning the individual stocks. But for those that feel better about the funds, then that’s a great way to go. You’re typically earning market-like (or benchmark-like) returns with low fees, while many also throw off pretty decent income. Nothing wrong with that! :)

      Thanks for stopping by.

      Best wishes!

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