Why do I choose Dividend Investing

This post is in response to a comment I received, saying that "dividends don't matter, because your total return (capital appreciation + dividends) would be the same, if the company did not pay a dividend but instead re-invested the cash". In theory, I must say, that is indeed true. But the key assumption here would be that the company is able to re-invest the excess cash at the same rate of return. However, I still prefer to invest for dividends, and in this post I will outline my reasons for my preference of dividend investing. I have been investing for dividends since 2015 and will continue to do so. 

As many of my long-time readers would know, I am pursuing FIRE, which is to become financially independent and retire early. Thus, for someone in my mid-20s, in some ways, I tend to think like a retiree. My reasons for choosing dividend investing is written with this in mind. 

In a traditional retirement portfolio, the aim would be to sell a portion of your stocks/bonds each year to fund your expenses. But what happens in a year when both stocks and bonds get decimated, like in 2022? By the way, 2022 is the worst year in a 100 years for the 60/40 (60% in stocks, and 40% in bonds) portfolio, as per Bank of America's research. 

Assuming the market tanks by 50%, a retiree who depended on selling assets to generate cashflows would have to sell twice the number of stocks/bonds to get the same amount of cash. Let's say a retiree has just retired with $1 million in 2022, allocating 60% to stocks and 40% to bonds. Following the traditional 4% drawdown rule, the retiree would want to receive $40k a year in cashflows, generated from selling a portion of their portfolio each year. In a year like 2022, the retiree would have to sell a greater number of stocks/bonds to generate the same $40k, which would deplete their portfolio permanently.

In contrast, someone with a dividend portfolio paying out 3-4% would be less affected. While dividends may be reduced during recessions, capital remains intact and there would be no need to sell during market lows. If one simply buys dividend paying ETFs, the stream of dividends are relatively predictable.

Many people began investing during the last few years, in a period of unprecedented outperformance of Growth vs Value. Understandably, most would gravitate towards Growth stocks to chase higher returns. But let me highlight that in March 2000, during the dotcom bubble, the Nasdaq peaked above 5,000 before the crash, and it took more than 13 years before it surpassed that peak in late 2014. 13 years of being underwater. Imagine if one had bought at the peak, one would have taken more than 13 years to recoup their capital. In contrast, a dividend investor would continue to receive dividends during those 13 years, somewhat softening the pain of capital losses. Now, if we believe that Growth stocks peaked in 2021 and that higher rates will continue to hammer Growth, we could very well have to wait another decade to before we see the Nasdaq at 15k again. Dividend cushion your portfolio and returns in volatile times like this.

Another reason for going for dividend paying companies would be if you believe you can re-invest the dividends at a higher rate than the company. Some companies are asset heavy with low ROEs, but are stable dividend payers (REITs, utilities and infrastructure). In this case, it would make sense for an investor to receive the dividends, and re-invest them to seek higher returns. 

Lastly, dividends tend to increase over time. Look at the dividend history of an index like the S&P500 or even our local STI. As companies grow, they also grow their dividends. This is why I prefer dividend paying companies over fixed income instruments, where the coupons are generally fixed.

A hypothetical Dividend Portfolio

Assuming I had $1.5 million SGD today, how would I create a dividend portfolio?

My aim would be to generate $50k SGD in cashflows annually (a 3.33% yield, very conservative in today's market), which is around the median income of Singaporeans. The instruments I would consider adding into my dividend portfolio would be, in no particular order:

SCHD - Schwab US Dividend Equity ETF, 2.47% yield, net of withholding tax
VEA - Vanguard FTSE Developed Markets ETF, 2.8% yield, net of withholding tax
2800HK - Tracker Fund of Hong Kong, 3.68% yield
STI ETF - Straits Times Index, 3.72% yield
S-Reit ETF - Any one of the S-Reit ETFs, ~6% yield
Singapore Savings Bond / T-Bill - 3.21% yield for Oct 2022 

I believe allocating my cash into all 6 instrument above would give me good exposure to a wide range of stocks across regions and sectors, which are well diversified. Even in a recession when dividends are expected to be cut, I believe having a diversified portfolio would mitigate the overall impact. 

Thus, in my view, if one is able to generate $40k to $50k annually with reasonable certainty, then whether the underlying portfolio rises to $2 million, or falls to $1 million, one should be indifferent. What matters is the consistency of cash flows, regardless of the market cycle.

As to how to reach that $1 million, $1.5 million or even $2 million... that's what my journey is about. Follow me on my journey to financial independence - I post monthly portfolio updates on @alpacainvestments on Instagram.   

September 2022 Portfolio Update and Further Thoughts on FIRE

Portfolio allocation as of Sep '22

SG Shares: DBS, SGX, Valuetronics

SG Reits: Syfe Reit+

US Growth: BABA, INMD, PYPL, SHOP, TDOC, UPST

Last month I began my post saying that “it was a good month to deploy capital”. This month was even better. I continued my DCA of QUAL and IQLT. Added a little to my Syfe REIT+ portfolio too. Markets are volatile, but with a significant portion of my portfolio in ETFs (62% in Sep vs 58% in Aug), and with a time horizon of forever, I am buckling up for the ride and staying invested. I look at stocks prices daily but I only compute my net worth monthly, because my holdings are spread across various brokers. The market volatility doesn’t really bother me – up or down, I continue adding to my ETF positions. Looking to add to my HS Tech and STI ETF holdings in the near future.

For US equities, I sold off PINS and TTD. These were the only two positions in the green and that means the rest of my US Growth holdings are in deep red… talk about loss aversion. The rationale for this is to raise cash for a position in GOOG. With the upcoming recession, advertising spending is likely to fall and I want to buy the best-in-class; Alphabet is the market leading behemoth in this space. I also have sights on ADBE – the Figma acquisition at 20bn seems like a steep price to pay at 50x ARR, but ADBE’s subsequent fall of ~25% since has effectively wiped out more than double that 20bn of value. One might conclude that you’re getting Figma for “free” by buying ADBE now.   

For my SG positions, I still have CDG, ThaiBev and FLCT on my radar. The focus is on building a robust dividend portfolio. SATS is also interesting with the sharp decline after they announced a huge acquisition. Large M&A transactions are usually negative as the acquirer tends to overpay and the post-merger integration is usually messy. But I’ve written extensively about SATS and understand the company well, and I believe that there would be a price which prices in all the negatives.

My tip for navigating the bear market - decide on a comfortable entry price, set your orders, and forget about it. Pursue other hobbies and don't check stock prices daily. Think long term. It will get better with time.

On REITs

My only REIT position is with Syfe REIT+. Generally, I think REITs still have room to fall given that yield spreads have compressed due to the risk-free rate going up. 

The following is adapted from a comment I made on the InvestingNote forum in response to a post on REITs:

“Think the biggest risk now is refinancing. REITs report their DPU “sensitivity” to rates, but this is only a snapshot at this point in time, which completely ignores the impact of refinancing. Any debt that’s going to be refinanced this year, 2023 or even 2024 is going to be refinanced at easily 4%+ or even 5% or 6%. This exceeds the NPI yields (cap rates) of most SG retail/office assets and results in a negative spread versus the cap rates. For example, if your NPI yield is 4%, and you borrow at 6% from the bank, it simply means that your financing cost exceeds your net rental. Thus the shortfall will have to come from equity holders’ returns.

I don’t hold any individual REIT positions. But what I’d do is to look at the debt maturity profiles of each REIT – in this context only knowing the weighted average debt maturity isn’t enough, we need to know specifically how much matures each year, especially 2022/23/24. A REIT that has a weighted average debt maturity of 5 years could mean 50% is due in 2022 and 50% in 2032, which still means the REIT is screwed, because 50% will be refinanced at sky high rates this year, and will be locked in for the next few years, bringing down DPU. Another REIT with the same 5 year weighted average debt maturity but has 10% of its loans maturing in each of the next 10 years is probably better positioned to weather higher rates. The exact loan maturity profile matters here.

The pain will come as all the cheap debt gets refinanced. Add in the fact that yield spreads have narrowed drastically, plus DPU declining over the near term. In a year’s time the average retiree may do better with a 100% SSB/T-Bill portfolio instead of REITs. Risk free for that matter.”

Further thoughts on FIRE

Further to my last post on “What does FIRE mean to me”, I came across some comments on other platforms which can be broadly classified as “pro-work” and/or “anti-FIRE”. If you are anti-FIRE, I would politely advise you to close this page now, because you won't like it, and in the following paragraphs there won’t be any discussion regarding the markets or on investing. The intention of my post isn’t to convince those on the other side of the fence (the anti-FIRE folks), but rather, for those on the fence to decide for themselves if they believe in pursuing FIRE. And more importantly, to serve as a voice of reassurance for the pro-FIRE folks who potentially have to face a barrage of criticisms from the pro-work camp, simply because we like to cruise through life and take it easy!

Two common arguments that anti-FIRE folks make are that 1) a job gives you an identity; without it you’ll be “aimless” and “lost”, and 2) a 9-5 job gives you “structure” and keeps you “disciplined”.

Let’s address both points. 

A job being your identity

I wrote about this before in my previous post, but let me summarise that here, with additional thoughts after.

1. My job is not my identity

2. My identity is made up of personality. My hobbies. My interests. My talents. The experiences I’ve lived through. My relationships with people. The lives I’ve impacted

3. I am intrinsically motivated by the above; not titles, not awards

4. I would suggest watching Sebastian Vettel’s video announcing his retirement from F1. A brilliant speech his on how his identity is more than just his job.

5. “Find a job you love, and you’ll never feel like you’re working”. Let’s be realistic. The hard truth is that there won’t be enough dream jobs for everyone. The majority of people are simply working to pay the bills. 

Let’s use my perspective as an example. I see myself as an investor. An allocator of capital. Analysing things, making inferences and projections. Seeking out the best ideas. This forms part of my identity, for sure. But I think what’s detrimental would be making your job your identity. That is, my identity is not tied to, hypothetically, being an investor at XYZ hedge fund / private equity / venture capital firm. To me, there is no difference whether I’m working for an investment firm or investing my own capital. I am an investor, first and foremost. It doesn’t matter where.

Of course, I can recognise the benefits of making your job your identity. It keeps you motivated. It keeps you going when times are tough. It gives you a sense of “purpose” to get up and go to work every morning. But doing this is a double edged sword. In good times you thrive. However, there there will inevitably come a time when, often beyond your control, some restructuring, reorganization or retrenchment happens. Or simply because you hit retirement age. That’s when you get crushed. You feel lost. You lose purpose.

Thus, even after one has achieved financial independence, I believe that having an identity is important. That can be the identity of being a good parent, a good spouse, a good son/daughter, a good sibling or even a good pet owner – spending time and effort with your loved ones and those that truly matter. Ultimately, it is our experiences and relationships that gives life meaning. 

You lose “structure” without a job

I find this reason even more laughable than the first. FIRE folks are mostly goal oriented, disciplined, intelligent people… or else... they won’t even be able to achieve FIRE. We simply don’t like things like workplace politics, deadlines or being told what to do. I think having discipline and creating your own structure comes from within. You have to be intrinsically motivated. 

Again, let’s use my perspective as an example. During the Covid lockdowns I was still in university. With so much time on hand, I did a wide variety of things. I started learning Spanish and French on Duolingo. I found an old digital keyboard and self-learnt how to play a simple song with both hands. I read many books. I attended many virtual AGMs and quarterly presentations. I spent time researching on stocks. I set aside two hours a day for some simple home workouts. In the evenings, I had virtual karaoke sessions and played other “lockdown” games with my friends.

And just like that, the few months went by in a flash. Of course, I recognise that I was privileged to be a student at that time, without having to worry about finances. But my point is that pursuing your passions and having a growth mindset doesn’t exclusively apply to having a job. I didn’t have a boss instructing me on what to do each day. I didn’t have formal responsibilities to keep me occupied. Yet, I was able to pursue a wide range of hobbies that I will continue to do so when I achieve FIRE. I had “structure”. I had “discipline”. And I didn't need a job to instill that.

The bottom line for me when addressing the two points above is that the “benefits” of having a job, espoused by the anti-FIRE folks, are in fact simply “positive traits”. You can basically replace the word “job” with any other scenario that would bring out the same “positive traits” of “purpose”, “identity”, “structure” and “discipline”. FIRE folks understand that. In addition to the countless benefits of achieving FIRE, such as freedom, pursuing your passions, being in control and having a safety net.

Closing thoughts

The idea of FIRE seems to be this radical concept that the average person believes is unrealistic, unattainable, unthinkable or all three combined. And so most of the comments online have these perspectives. Take my opinion with a pinch of salt as well.

At this point, perhaps I should borrow the term “mediocre” from one of our dear leaders (although in that context, the threshold for mediocre was way higher). In the following paragraphs I will use mediocre interchangeably with average.

The mediocre person is easily swayed by the opinions of other mediocre people on how life should be lived. The mediocre person is afraid of falling short of society’s yardstick of success, and tries to project an image of “success”, often through material possessions.

But to achieve FIRE, more often than not, you cannot be average. While it may be possible to be average and retire in your 50s, in this context I’m referring to people who aspire to or have retired in their 30s and 40s.

To retire in your 30s and 40s,

You must earn more than the average person.

You must be more frugal than the average person.

You must be more financially literate than the average person.

You must invest more aggressively than the average person. (Aggressively here is in the context of asset allocation, i.e higher allocation into equities, and not necessarily in “riskier” stocks within the equity bucket).

You must be more disciplined than the average person.

And lastly, as a catch all, you must not think and act like the average person.

If some of the points above describe you, then you could achieve FIRE. And if all the points above describe you, I can say with a high degree of certainty that you would achieve FIRE. If you want to. If you’ve built up a multi-million dollar portfolio and still want to continue working, by all means do. But you know you can walk away, anytime.

The average person won’t be likely to achieve FIRE. So, I don’t get why should there be concern of how the average person would “laze around”, “lose purpose” or “lose structure” if they were to achieve FIRE. Apart from winning the lottery or getting a huge inheritance, odds are that the average person would have to work till retirement age. That is the reality. 

Now, if you’ve read till this point and you firmly believe that you’re above average, do consider the fact that in a survey asking if drivers thought that they were “above average”, 90% responded that they thought so (from the book “Thinking Fast and Slow”, I believe). Food for thought.