Friday, May 1, 2009

Passive Dividend Investing

Cashflow is important, as I have mentioned in an earlier article here.

One of the ways to improve your cashflow is through dividend investing. Passive dividend investing can help build a form of passive income. Not only does it improve your cashflow, it also puts money into your pocket, and you do not need to do much to maintain it.

Some of my friends asked me, why invest so passively for dividends when one can do short term guerilla trading, entering and exiting the market in a short period of time and earn a lot.

To me, whether a market goes up and down is mostly due to traders. Some will lose, some will gain. But mathematically, logically and theoretically, the overall gain of traders is equal to the overall gain of passive investors.

Why is it so? It is because trading is a zero sum game, so on average, some the traders would have gains more than the passive investors, and some would have gains less than the passive investors.
The total gains of all winning trades minus the sum of all losing trades would be equal to the total gains (or loss) of the market. In addition, the gains of an average trader would be the same as that of the market.

The gains of passive investors, however, follow the market, excluding brokerage fees, and minus the effort and energy used to identify stocks in which to execute trades.

So, if we think we are average, or below average, isn't it simpler to just invest passively? Isn't it simpler to buy and keep stocks for the long term?

Why dividend investing?

Dividend investing works well for many investors. Dividend investing in defensive sectors will continue to provide a steady stream of income – income that can be counted on whether the market moves up or down. This stream of passive income provides cash which can be used or reinvested. Reinvesting the dividends will help the overall investment grow at a compounded rate (excluding brokerage fees). Adding to the fact that stock values traditionally increase over time, the new shares that are continually bought with received dividends will also increase, and at the same time, increasing the amount of dividends received.

Most dividend stocks (bank stocks are an exception) are also usually not as volatile. And because for defensive sectors, where dividends-payable are usually stable, investors face lesser risks. This is especially important and useful in a bear or sideways market, where investors will find it hard to count on capital gains to give them the returns they need. Dividend paying stocks also work well in both bear and bull market cycles. During a bear market, dividends provide a return on investment when gains from price appreciation are almost non-existent. During a bull market, dividends provide additional returns on top of capital gains.

Finally, for the Straits Times Index, it traditionally gains 7% compounded per annum. Yet in a bear market as of now, there are many a defensive dividend stock that yield 10% per annum. With dividend reinvestments, that will yield 10% compounded per annum. And all these are excluding possible capital appreciation!

Sadly, in a bull market with fast and furious price increases to seduce investors, many forget about the consistent returns and safety of the such stocks. History has proven the benefits of dividend stocks in almost any market condition. And with dividend reinvestments, one can generally expect increasingly greater dividend income.