Welcome to the inaugural edition of our new monthly feature - Dividend investor monthly. What is Dividend investor monthly? I’m not sure yet. We will all figure it out together as we go. The goal is to help you become a better income investor. That will involve some inspiration, some theory, some market intelligence and everyone’s favourite - some ideas.

This monthly feature is dedicated to a simple proposition. Financial freedom is synonymous with choice. The more you grow your passive income the more choice you have. Let's work on adding a little more freedom to our lives.

Why I invest for income

I often get asked why I’m an income investor. Sometimes the question is asked earnestly but often the derision is barely concealed. The derision typically comes from two cohorts of investors. There are the professionals who see income investing as simplistic and somehow inconsistent with the intellectual pursuit they are engaged in. Then there are the get rich quickers who think dividend paying shares can’t possibly be the next 20 bagger and are therefore unworthy of considerations.

I think there is a big difference between straightforward and simplistic. I think investors are far more likely to hurt themselves by overcomplicating things than simplifying things. And I think filling your portfolio with the next 20 baggers is a great approach that inconveniently is almost impossible to do.  

I recently wrote about our tendency as investors to associate complexity with competence. We gravitate towards complex investing strategies. Often at our peril. I think simple strategies and simple portfolios are better.

An investment strategy outlines the approach needed to achieve a goal. And since investing is a means to an end my goals represent what I want out of live.  My goal is to travel as much as possible. Travel costs money. To get more money for travel I buy shares that pay dividends. Since travel will increase in price and I want to travel more in the future I buy shares that I believe will grow their dividends faster than inflation.

Is this a simple strategy? Yes. I need money to spend so I buy shares that periodically put money in my pocket. I’m not using a factor-based strategy to add alpha. There is nothing about risk adjusted returns and the efficient frontier in my strategy. I don’t assess relative risk premiums or the business cycle to help me rotate my portfolio. There is no interest rate scenario where I will add duration. Nor take it away.

Many investors are trying to solve different problems than I am. I just happen to think the best way to improve my life is to be an income investor. As an income investor I am consciously not focusing on certain things. I’m not concerned if there are periods of time when dividend paying shares underperform. We are in one of those periods right now. Historically my portfolio tends to underperform when the market goes up a lot and outperform when it falls. I’m ok with that.  

Income investing is not as simplistic as I’ve portrayed it. To find investments that will pay increasing dividends in the future means finding shares that will keep growing earnings over time. It is the earnings that will fund the dividends. This requires assessing a company in the same way as an investor focused on capital appreciation. But there are some things I don’t have to worry about if I’m not trying to ‘beat the market’ each year.

An investor with a goal of beating the market every year needs to worry about the macroeconomic environment, interest rates, geo-political risks and the short-term catalysts for different types of investments. To do this means constantly monitoring your portfolio, forecasting short-term earnings, rotating your portfolio and continually reevaluating each position. This is the way successful investing gets portrayed in the media. It is also almost impossible to do. I will stick with my simple strategy.

A challenging environment for income investors

I’ve been vocal that I’m concerned about the prospects of the largest companies in Australia – and therefore the market capitalisation weighted ASX 200 – to deliver dividend growth at a rate higher than inflation. I didn’t bury the lead in my article titled Are we in the last days of ASX dividend dominance?

Janus Henderson’s Global Dividend Index is a great resource to explore trends in dividends from around the world. Australia is lagging when it comes to dividend growth. This first chart shows total dividends paid by year in Australia, The United States and globally.

Total dividends

Source Janus Henderson

This next chart shows growth rates in total dividends per year over the same period. As you can see dividends tend to swing significantly in Australia compared to other areas of the globe. This shows the impact of the cyclicality of the sectors that dominate the local market in combination with the high payout rates in Australia.

Dividend growth

Source Janus Henderson

These swings can obscure the slow pace of overall growth. Between 2017 and 2023 the growth of $1 in dividends shows the stark difference in growth between Australia and the rest of the world. The practical impact of this lack of growth is apparent using the RBA inflation calculator. Over the same period inflation meant that goods and services that cost $1 in 2017 increased to $1.21 in 2023.

Div growth

Source Janus Henderson

Income ideas

My colleague Jame Gruber has a similar view on the dividend prospects for major Australian companies. He recently wrote an article outlining his view and adding some picks. Give the article a read for his full list of picks but a few companies he finds attractive due to their decent yield, prospects for dividend growth and reasonable valuations include Medibank (MPL), Charter Hall Retail (CQR), Lottery Corp (TLC) – all sport dividend yields from 3.3% to 7.6%.

My favourite income investing metric in action

I provided an update for my 12 picks for income investorsin late January. I had two long-term goals for the shares and ETFs I included on my list. For the more growth orientated bucket I wanted to achieve average income growth of 10% per year. For the higher yielding shares I was targeted average income growth of 8% annually.

So far so good with total passive income growing 6.70% in constant currency and 9.72% in AUD over a little more than six months.

My favourite metric to track the success of my income portfolio is yield at cost. It captures the essence of successful income investing which is making sure each contribution to my portfolio generates a growing income stream over time. The yield at cost tracks the impact of dividend reinvestment and growing dividends on a passive income stream.

The following chart shows how the yield at cost has changed in the six months since I made the picks.

Yield at cost

The reason I like yield at cost is because it is a constant reminder that income investing does not mean buying shares and ETFs with the highest yield. The role growth plays in an income portfolio is underappreciated by many income investors.

In the case of my 12 income picks the yield at cost has grown even though the group of shares increased in value close to 15% in six months. Growing income faster than inflation is the pathway to financial independence as purchasing power increases over time.

Growth in income of 8% over 5 years assuming inflation is 3% would increase purchasing power by close to 27%. If income doesn’t grow in the same inflationary environment purchasing power will drop by a little under 16%. Focusing on growth is playing the long game.  

I would love to hear suggestions to improve Dividend investor monthly. Write me at [email protected] 

Articles mentioned

Get Morningstar insights in your inbox