There is a massive difference that exists between dividend-growth investing and growth investing—one that requires an entirely different mindset. To be successful long-term as a dividend-growth investor, it requires embracing a paradigm shift in how you approach not only your portfolio but, more importantly, your performance.
Almost everything out there today that is bombarding investors is pertinent to growth investing—not dividend investing.
For dividend-growth investors, failure to understand and embrace the required paradigm-shift in thinking—one that is frequently misunderstood and rarely discussed or taught—will inevitably lead to stress, frustration, emotionally-based decisions and, ultimately, investing failure.
This is one of the most important concepts to grasp for the retail dividend-growth investor, as it is a leading source of failure. With that firmly in mind, let’s explore this dividend-investing mindset and how it requires a paradigm shift from that of growth investing…
The fundamental difference between dividend and growth investing is the focus and mindset required.
Dividend-growth investing is entirely focused on income (or cash flow), while growth investing is focused purely on capital appreciation.
I cannot stress this difference enough—these two investing approaches reside in entirely different worlds, spheres, or paradigms!
As a dividend-growth investor, I absolutely could care less about capital appreciation. Rather, I am exclusively focused on income (cash flow) and my holding period is forever.
I literally do not care where the market goes—not tomorrow, next week, next year, or even 10 years from now.
You have to recognize that you own a fractional share of ownership in income-producing businesses. As such, you receive X amount of cash flow from those businesses you own and that will never change—no matter what market prices do!
Market fluctuations in asset pricing merely provide us with opportunities to reduce our yield-on-cost, meaning we generate more income for less invested capital. Stated differently, our capital efficiency is increased.
On the other hand, growth investing is entirely focused on capital appreciation. As such, those market fluctuations matter greatly. No capital appreciation—no profit and no success.
An important corollary to this is that timing is critical with growth investing. Get in at the top or sell at the bottom and you’re in a world of hurt. In essence, you are hand-cuffed to the whims of the market.
Now, this is not to say that growth investing is bad. To the contrary, growth investing—when your timing is correct—can be quite lucrative. However, it requires a very different mindset from dividend investing.
If you use the wrong mindset with either approach, the likelihood of a bad outcome significantly increases—as well as your stress level.
Understanding and embracing the required mindset of dividend-growth investing is one of the hardest challenges for new investors (and even many seasoned ones) to wrap their brain around—but it is critical if you want to be successful.
If dividend investing is focused on income (cash flow), then measuring your performance based on your portfolio value is not only meaningless but it can be counterproductive. Unfortunately, far too many dividend-growth investors employ a growth-investing mindset and focus on changes in their portfolio capitalization.
As a dividend investor, we must focus on income and ignore the capitalization side of the equation.
Joel Greenblatt has aptly noted that the best investment strategy is the one that makes sense to you and that you can stick with. Again, this implies understanding and embracing the dividend-growth mindset.
Peace is critical because stress leads to emotional decisions—which rarely have a positive outcome—and significantly reduces the likelihood that you will be able to stick with it and stay in the game over the long run.
Confidence is critical because success in the dividend-growth game requires contrarian thinking. The majority of the market is emotional and growth-oriented. You need the confidence in your strategy to zig when the herd zags. The growth-investing component of the markets will lead to overreactions in both directions—providing opportunities if you have the confidence to take advantage of them.
Finally, consistency is critical because (a) it will get you to your goals more effectively and efficiently and (b) it will materially reinforce the first two keys: peace and confidence. The strategy must provide an all-weather component—meaning it will perform in all market environments and reduces the need for timing.
An investing strategy that enables you to remain happy, confident and consistent will keep you in the game for the long-run and increase your potential for success.
The problem for most dividend-growth investors is that they apply a growth mindset to investing. The result is a loss of peace, confidence and consistency.
Instead, you must ignore short-run market fluctuations and evaluate your performance differently!
I don’t even look at my portfolio’s performance from a valuation perspective. Instead, all of my performance metrics are income related. In other words, I manage my dividend-growth portfolio like a business—focusing on cash flow rather than unrealized gains/losses.
As such, my primary performance metrics are dividends (income) and yield (capital efficiency)—not portfolio or asset valuations based on market pricing.
For example, I forecast my portfolio income (dividends & distributions) and then monitor my actual performance against it. Here is what that looks like for our Wicked Capital Passive-Income Portfolio (PIP):
Yes, I do include market-related portfolio performance metrics in our site’s portfolio updates. This was a difficult decision given that, as I’ve said, I don’t focus on or utilize these metrics myself and strongly believe that such a mindset belongs in growth investing—not dividend investing. However, ultimately, I chose to include them because:
What is critical to understand is that I actually welcome down markets—my cash flow remains unchanged, but it provides me with opportunities to buy additional cash flow for less capital.
The growth mindset views red as dead, while the dividend-investing mindset views red as green (for quality companies).
For the dividend-growth investor, it is all about current yield versus yield-on-cost (YOC). When current yield rises above YOC, I add—incremental cash flow is cheaper. When current yield falls below YOC, I add if I feel the market price is still at a discount to my valuation of the company.
This dividend-growth strategy—when properly understood and approached with the right mindset—provides investors with peace, confidence and consistency.
If you fail to understand and embrace the dividend-investing mindset, you will focus on portfolio value (capitalization). Unfortunately, rather than peace, confidence and consistency, this approach will lead to:
With the wrong mindset, your time horizon will get truncated to “now” when volatility exceeds your risk tolerance and you will buy and sell at the worst possible times.
Greenblatt did a study of the best performing mutual fund over the period of 2000-2010. He found that, while the fund produced an amazing annualized gain of 18%, the average investor managed to lose 11% a year on a dollar-weighted basis!
Why? How did investors manage to turn a massive gain into a massive loss?
Simple, they employed the wrong mindset! They utilized a growth-investing mentality that had them chasing the markets and short-run fund performance—causing them to move in and out at all the wrong times.
Here are two clips from interviews with Greenblatt where he discusses this issue—namely, employing the wrong mindset and the behavioral (emotional) consequences it produces:
Capital appreciation is an emotional roller-coaster ride—one that most retail investors do not handle well. However, if you understand and embrace the right mindset, dividend-growth investing will provide you with a much smoother and steady climb to success.
Most fund managers and retail investors have a short time-horizon—typically 3 years. As dividend-growth investors, we must embrace the right mindset—one that has a much longer time-horizon.
If we do, we have an advantage—patience. When you have a long time-horizon, you make very different decisions and employ a different process than if you’re only focused on doing really well (capital appreciation) 2-3 years from now.
While we don’t necessarily want to buy stocks that are going to perform poorly over the next 2-3 years, often, these are the very companies with the greatest potential long-term. The short-term risk is why you’re getting them at a bargain price!
If you’re not focused on capital appreciation, you don’t care how they perform over the short run—you’re busy locking in cash flow at a discount price. Furthermore, that cash flow will never go down (barring a dividend cut)—only up as dividend-growth occurs.
If you’re looking further down the road than 3 years, then you’re alone and have an edge. This edge is called time arbitrage. Embrace the dividend-growth mindset and (1) focus on income and (2) manage your portfolio based on metrics that correlate to the actual driver of your success.
The longer your time-horizon, the larger the potential opportunity that time arbitrage provides. Like Buffett, my holding period is forever. In fact, my portfolio will pass to my kids, where it will continue to produce and grow passive income for another generation… and hopefully many more beyond that. I have a generational-wealth perspective.
Currently, the probability of a recession has risen dramatically. While this doesn’t guarantee a near-term bear market, the warning signs are overwhelming. If you’re interested in exploring them, Victor Dergunov from Albright Investment Group recently published a great article on Seeking Alpha that outlines a host of them https://seekingalpha.com/article/4286282-oh-yes-recession-coming
What does this mean for the average dividend investor?
If you have started or materially increased your portfolio over the past 12-18 months, you are likely headed for RED—and potentially a lot of it!
If you haven’t embraced the dividend-growth investing mindset, you are on the edge of the danger zone. As that red potentially grows, so will your stress-level and emotional mindset. Your risk tolerance will be pushed to the max and you will be focused on how to limit the “apparent” damage and pain (aka selling) at the very time you should be confidently focused on capitalizing on long-run opportunity (aka buying).
[I use the term “apparent” because these losses are unrealized—not permanent!]
Your mindset matters! Wherever your DGI portfolio is currently at, you have locked in a certain level of cash flow. Your portfolio value (capitalization) doesn’t matter—that cash flow (excluding any dividend cuts) will not change.
Market fluctuations simply don’t matter over the next 1, 2 or 3 years of a potential bear market when you are looking 10, 20 or 30+ years down the road.
What will matter is the opportunity for time arbitrage! Any potential red caused by a correction, recession and/or bear market is a BIG positive for the dividend-growth investor with a portfolio of quality companies—not a negative or something to make you shake in the knees and vomit.
Any red is simply a fantastic opportunity (with proper analysis and process) to lower your yield-on-cost and in lock-in more cash flow for less capital!
In fact, the best time to build a dividend-growth portfolio is when the markets are falling. Everyone else is running for the exits, but—as a contrarian investor with the proper mindset—you are positioned to graciously grab-up their future cash flows for bargain prices.
Real estate investing is very similar to stock investing and provides a great analogy to this mindset dichotomy—one that will hopefully help to clarify the critical differences for you in your mind.
In real estate investing, you have flippers and you have developers.
Flippers are like growth (or pure value) investors. They buy a property at what they believe to be a low price with the hopes of quickly selling higher—meaning it’s all about capital appreciation. Now, they may make improvements to the property to drive a portion of that appreciation; however, the point is that they intend to “flip” the property to capture a capital gain.
On the other hand, developers are like dividend-growth investors. They buy a property with the intention to (a) own it long-term and (b) generate income from it through renting it. That income can then be reinvested into additional income-producing properties.
These developers are building income-producing portfolios of properties. They don’t care if the housing market was to crash in the short-run and a real estate agent told them their property is now worth 30% less than they paid for it.
Why? Because those properties are still generating the same income (cash flow) from rent.
They have no intention to sell them, so who cares if they are theoretically worth less today—as long as it continues to crank-out the cash flow. Furthermore, that cash flow will likely continue to grow over time as rents are increased (like dividend-growth).
As that cash flow is reinvested, their portfolio—and their income—continues to compound and grow!
Now, without doubt, real estate investors can make money with either strategy—just like stock investors.
However, flippers better be extremely skilled at (a) identifying short-run value opportunities and (b) very effectively timing their flips. During boom cycles in the housing market, all flippers look brilliant. However, when that bear wakes from hibernation, the very real danger exists for the majority of them to lose big—really big depending on their leverage.
On the flip side, the developer isn’t impacted by market fluctuations. Rather, they simply embrace the opportunity to capture additional income-producing bargains within the current market and continue expanding their portfolio of properties and building their passive income. Rents (like dividends and distributions) are minimally impacted by those market gyrations.
However, if those developers didn’t understand and embrace the proper mindset, as soon as the market cycle turned and they started seeing red in those property valuations, they would likely panic and say, “Oh man, I better sell now before it gets any worse!”
Now, that obviously sounds ridiculous to us—we know they wouldn’t actually do that! They would see opportunity everywhere to buy more income with less capital from a now growing group of discounted properties.
But that’s the point! They wouldn’t do that because their focus would remain on income streams—not unrealized capital gains/losses. That is precisely the mindset we must embrace for dividend-growth investing.
Sadly, while it may seem ridiculous and laughable when we think of it in terms of real estate, so many dividend investors struggle with embracing that very mindset and do exactly the opposite when it comes to stock portfolios!
I think a big driver of that is that you aren’t bombarded with property valuations 24/7 in real-time… but we are when it comes to the stock market!
We have to understand our process, have confidence in it, and stay with it! Ignore the portfolio value fluctuations and focus on building income and embracing long time-horizons.
Dividend investing and growth investing are two entirely different approaches—approaches that require radically different mindsets.
To achieve long-term success in dividend-growth investing, you must understand and embrace the required mindset:
This is not easy—especially when the sky is falling in the immediate term. It requires a paradigm shift in your thinking; however, if you embrace this mindset, you will generate:
Dividend-growth and compounding will take care of the rest—as long as you have a good process.
Any capital appreciation you achieve 40 years from now will just be a bonus—the proverbial icing on the cake!
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