Sunday, 29 November 2009

Dividend incomes do not depend on the kindness of strangers

The vast majority of stock transactions are simply investors selling the same stocks back and forth among themselves.  Prices change as their opinions change about what each share is worth to them.  They rise as a buyer tries to entice an owner to sell, and they fall as sellers try to attract a buyer.

Assuming that your stock has risen in price since the day you bought it, how do you benefit from this increase in your wealth? 
  • You could borrow against your shares, but then you're really using someone else's money, and the stock is just collateral.  You still have to repay the loan, plus interest, somehow.
  • If you ever want to spend the money, you have to sell the stock.  In order to sell your shares, you have to find someone to buy them.
Dividend incomes, on the other hand, does not depend on the kindness of strangers in the same way that appreciation does.  Dividends are driven primarily by the ability and willingness of the company to share its profits with its shareholder owners.  They are tied more closely to the business itself and are less subject to the emotional response of investors to world or market events. 

Investors holding stocks for the income they provide, on the other hand, enjoy an ongoing advantage that "pure growth" investors don't  - they get to keep their shares.  Obviously, once you've sold your shares, it's somebody else's stock.  You no longer have a stake in the fortunes of the company.  The benefits and profits that may follow - as well as the future appreciation in share price - are of no further value to you.  Of course, you don't necessarily have to sell all your stock at once and can therefore continue to enjoy some of the good fortune that may continue to visit the company whose shares you're selling. 

The simple fact remains, though, that as you sell your shares, you have less of an ownership interest than you did before.  By periodically liquidating your holdings, you are systematically reducing your ownership in the very thing that is your store of investment wealth.  Appreciation has its advantages too, and fortunately, dividend investors can enjoy the appreciation in the value of their shares while they continue to collect the ongoing income from their holdings.

When the time eventually comes to take income from your portfolio to support your lifestyle, either in retirement or to help defray major expenses such as education costs, the investments do not have to be sold to create cash flow.  The dividends are already flowing cash to you.  You simply have to adjust how much of it you're reinvesting and how much of it you can afford to spend.

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