Over the years, I've been asked the same question: How do I build a flexible portfolio that will continue to meet my long-term needs? Since I write the Fool's dividend-stock newsletter, Motley Fool Income Investor, it won't surprise many of you to hear me say that I believe a dividend-oriented portfolio achieves the best of all worlds, for all people. But after a recent visit with a large group of investors, I believe it's more important than ever to say so.
Though a dividend-oriented strategy would seem like an easy sell to many of you, that's not necessarily the case with the average investor, young or old. About a month ago, I had the pleasure of speaking at the National Association of Investors Corporation's convention in Atlanta, and this fact was driven home by some of the questions posed to me there.
It seems that many older investors have overlooked the dividend-oriented investment strategy altogether. Instead, they've gone with the oft-preached tack of buying "growth" stocks throughout their younger years and adding an ever-larger portion of bonds as they approach retirement. Interestingly, the concept of relying solely on income from a stock portfolio is foreign to many of them.
I think this is largely because dividend yields have appeared too low to convince folks that they would receive adequate income when they need it. Of course, what they've failed to consider is that the best companies, such as Bank of America (NYSE: BAC ) and AGL Resources (NYSE: ATG ) , tend to increase their dividends at rates well above the rate of inflation. Thus, the yield on their original investment would prove much more meaningful over time.
Get flexible at no cost to you!
Certainly, there are many things to like about a dividend portfolio. That your stocks fall just half as much as non-payers during bear markets is an obvious one. Then there's the fact that, despite the lower volatility and business risk, your long-term returns tend to be higher than those of the market as a whole (by at least a couple of percentage points over nearly any period).
But at its core, a dividend strategy is about ultimate flexibility. As I've said, it lets you have your cake and eat it if you want to. In other words, if you need the income, you take it. If you don't, you reinvest it until you need it. And by then, you'll likely have the means to produce a larger income than you could have imagined.
For the older folks who are looking for income, there's more flexibility with a dividend portfolio today than at any other time in history. Consider that most brokerage firms and Drip plans now give you the choice between reinvesting dividends or receiving cash payments at the individual company level -- sometimes even at an individual share level.
For example, say you have a portfolio with 20 dividend-paying stocks. Most firms now let you reinvest dividends on your entire portfolio. Otherwise, you can pick a few companies for reinvestment and get the dividends on the remainder of the portfolio as cash. Indeed, some account providers will let you go a step further and specify the number of shares of a given holding on which you'd like to reinvest or receive the dividends. Thus, you have considerable control over exactly how much income you'd like to receive as cash at any one time. Turning the spigot on or off doesn't come so easily with any other strategy.
Then we have the younger folks (for our purposes, that could mean anyone from ages 20 to 60). The reaction of these people to the title Income Investor is easily predicted: "But I don't need income."
My response, of course, is that it doesn't matter. If you don't need income from your dividend portfolio today, you simply reinvest it. "But won't I have to pay taxes on the dividends when they're paid?" they ask. Yes (unless you're holding it in a tax-free account), but it still doesn't matter.
As I mentioned last month, beyond singling out good companies up front, choosing to reinvest dividends is the most important investment decision you'll ever make. According to data compiled by author Jeremy Siegel, reinvesting dividends in quality companies beats all other investing strategies hands down.
Indeed, if you'd begun investing in 1897 and reinvested your dividends along the way, 97% of your account's value today would be the result of reinvested dividends. This means capital appreciation accounted for 3% of the total. Which would you rather have: the 3% received by the so-called growth investor or the 97% the dividend investor got?
This best illustrates my goal for the Income Investor newsletter service. I'm not merely looking for good stock picks here. I also want to provide you with a low-risk, high-return, lifelong solution to portfolio management.
The bottom line is that investors need to realize that a dividend-oriented strategy offers something for everyone: the ability to beat the market while maintaining flexibility. If you're young, reinvest your dividends and beat the returns of all other investors. If you're a little older, build the most flexible and diverse income stream possible. And in either case, sit back and enjoy your results.
Despite his childlike picture, Mathew Emmert is only young at heart. He owns none of the companies mentioned in this article. Mathew is the author of Motley Fool Income Investor. Bank of America and AGL Resources are Income Investor recommendations. The Fool has adisclosure policyfor young and old alike.