In a recent piece, I broke down my dividend income stream for the prior year. I was pleased to see that the passive income that my portfolio produced rose nearly 77% y/y in 2017, mainly due to capital inflows into the portfolio during 2016. In this piece I wanted to delve a bit deeper into the compounding produced by my passive income stream, looking at all of the dividend re-investments I made throughout the year and how much value that created for my portfolio. Spoiler alert: the value was significant and this piece should help to convince naysayers that dividend growth investing is indeed a valid long-term wealth generator and/or comfort those who’ve already adopted the strategy as their own as we continue to see the positive data roll in.
As many of you know, I don’t DRIP, I selectively re-invest. What this means is that I don’t automatically re-invest the dividends that I receive back into the companies that paid them. Instead, I pool my dividends throughout each month and then on a pre-scheduled date, I use the passive income that I’ve received over the last 30 days or so to add shares to my portfolio. Thankfully, both of the brokerages that I use allow me to do this for free, so even though the purchases that I make are relatively small compared to the normal trades that I make in the market, commissions don’t eat away at their effectiveness.
Even though I don’t DRIP, I like the idea of regularly selectively re-investing because it allows me to constantly dollar cost average into the market. I think dollar cost averaging is an important strategy for retail investors; I wouldn’t manage my entire portfolio like this, but having pre-scheduled dates to add exposure to equities helps to remove any emotions that might be involved (namely fear, which might otherwise cause me to avoid what have turned out to be lucrative opportunities) and ensure that I’m growing my portfolio throughout a wide variety of market environments.
Another aspect of selective dividend re-investment that I like is that it gives me the opportunity to re-balance my portfolio using organic growth. Using dividends to re-balance over time helps me to avoid sales when individual positions and/or industry/sector exposures get too overweight. Using dividend income to add to underweight areas of my portfolio over time helps to even out my exposure and meet my asset allocation goals.
And lastly, using dividend income to selectively re-invest gives me the freedom to make purchases that I might not otherwise make with new money. What I mean by this is that I allow myself to relax, or even break, the rules/standards that I have for making investments with regard to value.
Typically, I’m pretty strict when it comes to buying value. Whether it be in the stock market or at the grocery store, it’s difficult for me to justify paying up for things. I like buying things when they’re on sale and my frugality has evolved to the point where I sometimes feel guilty and even sad when I end up paying full price. This can be frustrating at times when it comes to portfolio management because there are so many wonderful companies in the market and oftentimes, these wonderful companies demand premium prices. Not only do I like buying value, but I like owning best in breed assets, which, more often than not, ends up being a catch-22.
Well, dividend income helps solve this conundrum for me, because whether it makes logical sense or not, I’m able to mentally justify higher risk with my portfolio’s organic income because in a way, I view it was “free money.” I’ve written about this before and I know it’s not a logical way to look at it (dividend dollars are no different than the dollars you get in your paycheck or the ones you find hidden in your couch cushions). But, I’ve always viewed my dividends in a different light because I know that they aren’t earmarked for anything else.
What I mean is, when I get a paycheck, I can spend it on any number of things. I pay my bills, I pay my mortgage, I buy dog food, and maybe a video game every now and then. I set aside money for gifts for my wife. We save up for vacations. And of course, we set aside money for savings.
Well, as you can see there are a myriad of things can I can do with my money. We’re all in the same boat in that regard. I know saving/living below my means is important and the difference between financial freedom and working until I’m on my deathbed. I think I do a pretty good job of being fiscally responsible. My wife probably thinks that I do too good of a job (she gets frustrated with my relentless budgeting). Regardless, all of these financial decisions take planning and discipline.
So much planning can sometimes be stressful. Luckily for me, one thing that doesn’t require much thought (or stress) is the fact that all of the dividends that my portfolio produces are put back into the portfolio. As a young DGI investor, I’m in the accumulation phase. My strategy is built around the long-term compounding of assets. I’ve done a lot of forecasting with regard to compounding over time and I know what it will take to meet my long-term goals. Because of this, I don’t even consider allocating my dividends towards those other expenditures listed above. One day, they’ll pay for things like dates with my wife, but not today.
It’s easy for me to set this money aside and view it in a different light because of its passive nature. Even though those dollars are technically the same, they feel entirely different to me. I didn’t work for them, or at least not directly. It feels good when you know that your money is working for you so that one day you won’t have to work for it. These dollars aren’t meant for spending; they’re meant for building. It’s as simple as that.
So, here’s the building blocks that I added in 2017 with my passive income:
Unlike in past years where I re-invested 100% of my dividend income, I only re-invested ~67% of my dividends in 2017. Because of some extenuating circumstances regarding cash withdrawals to pay for my wife’s graduate school tuition, I used some of my dividends to fortify my cash position. I don’t necessarily like the fact that I didn’t use 100% of my dividends to grow the portfolio’s equity exposure, but then again, one’s cash position is an important part of risk management and I’m glad that my income stream allowed me to bolster this defensive measure without having to sell quite as many shares otherwise.
What I do like is the fact that the shares that I did buy during selective re-investment periods increase in value by nearly 12% during 2017. My portfolio’s yield was 1.81% (2.02% ex-cash), but if you factor in the growth of the shares that my passive income purchased during the year, the value of my dividend stream amounted to a yield of 1.96% (2.18% ex-cash).
What’s more, this 11.97% doesn’t factor in the added income that the shares that I bought via selective re-investment added to my current income stream. Not only will should the value of the shares that I add organically each year grow, but so should the income that the vast majority of them produce.
As you can see above, a lot of my focus with re-investments in 2017 was centered in on growth. I began building my position in XLK in 2016 and finished that off in the first half of 2017. XLK has been a real winner for me and while I know people buy technology for growth (as do I), I wholeheartedly expect for that fund to continue to produce a rising stream of income as well.
My next two largest passive additions to my portfolio were Microsoft and Activision-Blizzard. I like both of these companies long-term. They’ve been shown tremendous growth in the recent past as well, which has lead to valuations well above historical averages and stellar capital appreciation.
I’ve owned Microsoft since it traded in the low $40’s, but for awhile now I’ve wanted to increase my MSFT exposure to the point where it is on par with some of my other large tech positions, Apple and Alphabet. MSFT has traded above its historical average for awhile now (due to the wonderful growth in the cloud segment inspired by Satya Nadella’s grasp of the reins), meaning that I haven’t been interested in placing a large bet at current levels. However, slowly, but surely, I’m growing the position on a monthly basis and ~18% gain that I received on selectively re-invested MSFT shares in 2017 just goes to show that sometimes quality matters more than valuation.
Activision-Blizzard doesn’t carry the same sort of name recognition amongst DGI investors as Microsoft, but valuation aside (ATVI has a habit of trading in the 30x earnings range), I really like this company. Video games have proven to be an attractive growth area of the market and I think ATVI has the best content IP in the industry. I also really like what they’re doing with eSports, and specifically the Overwatch League. I don’t think eSports are a fad and ATVI is proving itself to be a leader in this up and coming area of media/entertainment. Like MSFT, I’m slowly building a position in this overpriced, yet high quality company. In a few months I will be finished building out my ATVI position to an acceptable entry level weighting without having to dip into my cash position to do so.
Most months I like to balance out my re-investments by purchasing shares of a high growth company and then a high yielding or deep value name. Thus far, I’ve found that this strategy works well for me, both in terms of market results and the peace of mind I receive knowing that every month, regardless of what my savings were or where my cash position in the portfolio sits, I will have the opportunity to add to my holdings and grow my income stream, organically. It makes me even happier to know that because of the dividend increases I receive every year, combined with the organic share additions, I will be able to buy more and more shares with the “free money” in the future. This is dividend growth investing at work. It’s the power of compounding. It is why I’ve chosen an investment strategy based around a reliably increasing passive income stream as my means to reach financial freedom.
Disclosure: I am long every stock highlighted in the graph above.