Dividends will hopefully play a big role in providing an extra income stream as we head towards FIRE. In this post I'm going to share 4 reasons why I'm a big fan of quality dividend stocks.
1) Investing in big, well-established companies
I really like investing in things that are embedded in our everyday lives.
Think F&B (Starbucks, McDonald's), basic hygiene (Colgate, Proctor & Gamble), technology (Apple, Microsoft), healthcare (Johnson & Johnson) and other consumer goods (3M, Clorox).
How about the places you go to buy these goods? Walmart, Target, Walgreens, CVS.
Wherever you are in the world, you've likely not only heard of these brands, but have used their products at some point, maybe as recently as last week.
2) Dividend stocks are an income-generating asset
If you buy a rental property, you’re probably less concerned about the short term valuation of the property itself, as long as you keep receiving rental income
The same is true for dividend stocks - it’s easier to sleep at night knowing the stock price might drop, but the dividend will continue to be paid.
Yes, some companies stopped paying dividends in 2008 and again in 2020, but many did not.
Many have been paying (and increasing) their dividends longer than most of us have been alive!
3) Truly passive income
Not only do dividend stocks generate income, they are one of the few investments that truly generate that income passively.
In the rental example, maybe you could go a year or two receiving rent passively. But at some point the property will need work, or the tenants will break something, or your management company wants to renegotiate their contract.
For me, I'm too lazy to deal with all of that. I just want income to hit my bank account without me having to lift a finger - and dividend payments fit the bill.
4) Reduces the need for drawdowns in retirement
Specific to FIRE - dividends reduce the need to sell your FI assets.
The 4% rule requires selling 4% of your FI assets annually.
I don't know about you but I would find it difficult to sell assets I've spent most of my adult life accumulating.
However, if my annual expenses are $40k and I receive $10k in dividends, then I can use a smaller drawdown, maybe 3%. That buffer will definitely help me sleep better at night.
But aren’t individual stocks risky? Can’t their stock price go to zero? Well yes, of course.
But I’d like you to conduct a simple thought experiment and think about the conditions that would cause every single MacDonald’s branch in the world to shut down, and for McDonald’s to go bankrupt. Not impossible, but if that happens, I suspect the world has bigger problems.
Remember dividend stocks work hand in hand with ETFs, it’s not a mutually exclusive choice.