More Cash When You Need It

As most folks (including me) would have it this week, the bull is back and the bear is in hibernation.

But don't be fooled. We all like our stock prices going up, but whether they do depends more on how the business performs over a period of years than how the price wiggles and squirms over a few months.

Secular (long-term) bull and bear markets do matter, because of the long-term expansion and contraction of price-to-earnings (P/E) multiples associated with them. Pay too much for your star-studded performer, and the contraction of the P/E multiple will eat up the difference. Investors who bought Amazon.com (NASDAQ:AMZN) in 2000 learned that painful lesson.

So as we've always said here on Fool.com, "Buy good businesses at reasonable valuations and add regularly to your holdings." In current terms, that means having the cash on hand to buy solid businesses with heaps of free cash flow, such as Microsoft (NASDAQ:MSFT) or United Technologies (NYSE:UTX).

Reliable sources of cash
There are a few ways to make sure you have a constant stream of cash available to take advantage of bargains. The least attractive of these options is to regularly recalibrate your portfolio by selling off the most highly valued positions and rotating into undervalued companies. Even for a skilled investor, that's a difficult proposition, because taking advantage of an attractive opportunity requires paying constant attention to the valuation of each and every holding.

The easiest method is to regularly add cash to your account. There's no rule that says you have to pick a stock each month to put the money into, but if you're regularly adding funds to your brokerage account, you're guaranteed to have funds handy when an opportunity arises to pick up Wal-Mart (NYSE:WMT) or Dell (NASDAQ:DELL) when investors are losing interest or worried about the next quarter.

My favorite method for making sure I have cash is to invest a large portion of my portfolio in dividend payers. This way, throughout the year there is a steady stream of cash coming in to bolster my portfolio. And with discount brokers charging approximately $10 a trade, it takes only about $750 to keep the average purchase commission below 1.5%.

Dividends at work
Dividend payers may get labeled as unsexy, but the actual cash they throw off is a very beautiful thing for a portfolio. With a $50,000 portfolio in a tax-deferred account like an IRA (or tax-free account like a Roth IRA) yielding 3% per year, an investor would receive $1,500 in the first year, which could be put back to work in his or her portfolio. But it doesn't stop there. Most dividend payers pay out each year by an amount that is relatively close to the growth in earnings. Sysco (NYSE:SYY), for example, has increased its dividend by 20% per year over the past six years.

In the table below, I've elaborated further on the fictional $50,000 portfolio mentioned earlier, assuming the same 3% initial yield and an 8% annual increase in the total amount of dividends received.

The fact that an investor would be staring at $3,000 in dividends received in Year 10 is fairly impressive, but not nearly as remarkable as the $21,729 total received over the 10-year period. The example above is relatively simplistic because it assumes that greater dividends are received on the original amount invested and then invested in a non-dividend-paying company such as Pixar (NASDAQ:PIXR).

In other words, the investor isn't taking advantage of reinvesting into additional dividend payers. In such a scenario, the results would be much more pronounced, because each year the investor would have a greater number of shares pumping out more and more dividends.

Foolish final thoughts
This exemplifies the powerful effects of dividend investing on a portfolio, particularly one that's shielded from the tax man for a number of years.

As impressive as those results are, our Income Investor service, with an average yield of 4.7% per selection, looks like it is positioned to deliver even more impressive long-term results. If investing for dividends and growth sounds like your thing and you're interested in learning about companies that can give your portfolio a boost in cash flow, take a free trial to our Income Investor service. Every month, lead analyst Mathew Emmert recommends two dividend-paying companies for his subscribers. After a little more than two years, his recommendations are beating the market by an average of three points and 11 have beaten the market by 15 points or more.

Nathan Parmelee owns shares in Microsoft but has no financial stake in any other companies mentioned. The Motley Fool has an ironclad disclosure policy.