Are Dividends Important?
Many investors like dividends. They see it as a regular source of income from their investments.
But what are dividends? Dividends are the portion of earnings that is given back to the shareholders of a company or fund. Unlike bank interest or bond coupons, dividends are not guaranteed. Yet, some companies and funds are well-suited to give out dividends regularly, and even increase payouts consistently. This is largely due to the industry they operate in or the assets they hold.
We see several “old economy” organizations, such as those in real estate, consumer goods, and pharmaceuticals businesses, being “dividend aristocrats”. These companies are usually well established, with high economies of scale, popular brand names, familiar competition, consistent revenues, and stable profit margins. They are also called “cash cows” and are in a mature phase of their life cycle. These companies typically do not need additional retained earnings on their balance sheet because that would lower their returns-on-assets performance.
On the other hand, “new economy” organizations such as those in technology-driven sectors with “disruptive” business models tend to retain most or all of their earnings to further invest in their new ventures. These are usually high growth companies.
A good exception to the above scenarios is Warren Buffett’s Berkshire Hathaway.
While regular dividends make sense for some types of investors, for most others, it is recommended that they simply reinvest the dividends for maximum benefit of compounding growth. The latter investors can also generate their own “dividends” whenever they need the cash by selling a small portion of their financial investments.
The fact that dividends are not guaranteed means that one cannot rely solely on it for one’s retirement income. Dividends are to be treated as a nice bonus that can fund your next holiday, a new gadget etc. Better still, reinvest the money to grow and to hedge against inflation.
If you wish to gain clarity on where you are headed in your investments and retirement planning, get in touch with me today!
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