From the Mailbag:
What age should investors start buying dividend stocks for retirement?
A lot of us are told early on that the younger we are, the more aggressive our portfolios should be. Dividend stocks are for retirees, and young investors should be chasing the next supercharged growth stocks. After all, the younger we are, the longer we have to make back any losses. I couldn’t disagree more.
Safe dividend growth stocks should be a significant part of every investor’s portfolio, regardless of whether the investor is 20 years old or 80 years old. In fact, I argue that dividend stocks should be one of a young investor’s first purchases.
Don’t get me wrong, risk-taking is important. But investors, regardless of age, should never gamble with their money. Risk has to be managed. Unfortunately, risk management – like trailing stop losses and diversification – is a lesson that is sometimes not learned until it is too late.
While working on Wall Street, I saw the damage reckless risk-taking can impart on a new investor. One of the firm’s top salespeople, a 25-year-old broker who had been licensed for a few years, decided he was going to make a fortune on the next big biotech stock. Backed by the firm’s research analysts, he’d made his hedge fund clients a lot of money buying, selling and shorting stocks. It was time to book some of those gains for himself.
A firm rule forbade employees from trading on our recommendations. So he decided to act on a tip he received from a “smart” hedge fund analyst who also happened to be one of his clients. He spent $10,000 – his entire life savings – on a biotech stock with a drug expecting FDA approval in a few short months. His client at the hedge fund told him he had built a sizable position in his own personal account and the stock would skyrocket after FDA approval. Being a great salesperson, but a questionable researcher, the young broker conducted very little due diligence on his first purchase.
I’m sure you can guess what happened next. The drug was not approved and the stock went to zero. He lost everything and then some.
Think about it this way. That young investor not only lost his $10,000 life savings, but he also missed out on much more. He should have invested in a dividend stock and enrolled in a DRIP (dividend reinvestment plan). The power of compounding is precisely the reason young investors should start their dividend growth portfolios as soon as possible. With retirement 30 or more years away, young investors have the luxury of juicing up their portfolios by reinvesting the dividends.
To some, the dividend mindset is a bit different than the aggressive growth strategy often recommended to young adults. With an aggressive growth strategy, investors are typically looking to multiply their net worth quickly. Dividend investors can have a growing income stream as well as multiply their net worth.
Let’s say my friend bought $1,000 of a $10 dividend stock yielding 4%, or $0.10 per quarter. For the sake of simplicity, assume the stock price stays the same. In just 10 years of dividend reinvestment, he would have generated a return of nearly 84%. That’s without any capital appreciation!
Unlike retirees, most young investors are working and have no need to live off of their investment income. They never miss it. Twenty to 30 years from now, that portfolio is throwing off a large enough income stream that they don’t need to work to cover their monthly expenses.
I’m not saying investors in their 20s should avoid aggressive growth strategies entirely. But I do think dividend stocks are the most logical way for new investors to learn about the market. They are less volatile and have growing cash flows, which leads to dividend raises, which is positively correlated with rising stock prices. And if the market tanks, these businesses are much more likely to survive and thrive than a high-flying social media company operating in the red.
Don’t forget: Successful investing is directly correlated with what you keep, not how much you lose during your investing career. Losing money on risky investments should not be an investor “rite of passage.” Dividend investing is a strategy for all ages and the earlier an investor gets started, the better.