MT15 | The OG Of Passive Income (Dividend Investing)

It is common nowadays to fantasise about side hustles that will earn us a tidy passive income so we can eventually quit our jobs and chase our dreams. So we give up our weekends drop-shipping products from China or selling keychains on Etsy or making podcasts and Youtube videos in the hope that we’ll magically stumble into a niche and make massive amounts of money overnight. But that rarely happens – and definitely not without a lot of work. So why bother, especially when there’s a far easier way to earn truly passive income with very little effort?

Discussion Topics: The OG Of Passive Income (Dividend Investing)

• Side hustles usually take a lot of time and could easily have a lower ROI than your day job
• You can make truly passive income – zero effort money – investing in dividend stocks
• These are great for your portfolio because you get income, inflation protection, stability and appreciation
• There are of course downsides: dividends could be cut, dividend stocks don’t appreciate as fast as growth stocks and you will likely pay income taxes on the dividend income

Transcript: The OG Of Passive Income (Dividend Investing)

Hi, everyone, welcome to another episode of MoneyTok, where we help make personal finance and investing simple and accessible through both my own experience. I’ve been doing this for about 20 years now. This show is about money and wealth creation. And we talk about so many ways of making money, bought retirement planning about stocks, bonds, gold, real estate, crypto, and so many kinds of things.

Regular listeners would know that most episodes of MoneyTok come with a free tool or template that you can use to accelerate your own financial journey in fact over the past 15 episodes we have built quite a library and we are pretty proud of them. For today we have a checklist that helps you stay away from so-called dividend traps which look good on the surface but actually turn out to be lousy investments.

As you know, last year a lot of people suddenly had a lot of time on their hands, because, you know, Covid. Myself included. So I thought I’d try my hand at something I’ve been thinking about for a long time, which was to start a podcast. This podcast, in fact, as you might have guessed because you’re tuned into this show and hence by definition smart, sexy, and overall a gem of a human being. How hard could it be? Just click record and talk. Right?

Wrong. First I had to buy a decent mic and audio interface for the podcast to sound professional and not like a random guy in a bedroom. Because do you really want to get money advice from a random bedroom guy? No, I figured not. Then I had to spend some evenings and weekends teaching myself how to use Garageband. Then make the tech work. Then research and write a script, edit the audio, make a website, and write show notes. Hours and hours of work for just one episode. And sure it got a bit easier with time but still, each episode is a lot of work.

And I have to keep at this for months and maybe years before the show makes a dime. So yes, eventually my podcast can make income, but by no means passive income. It’s about as active as it can get. In fact, if you’re an office worker, you’d likely make way less per hour of podcasting than you are probably getting at your real job. So is this the best way to earn so-called passive income?

No, it isn’t. Passive income should mean you make money doing nothing. And the passion economy and side hustles are not the way to get there. But the financial markets are. And one of the best ways to make decent free money is through dividend stocks. Let’s see how.

As usual, once you’re done with this episode, feel free to click the link to our website where you can access all the free resources we’ve made to help you get started on your investing journey. For today, we have a pretty comprehensive checklist on how to spot a great dividend stock to add to your portfolio – and how to avoid so-called dividend traps that look good at first sight but are poor investments in reality.

Before we talk about dividends, we need to touch upon the concept of profit. Profit is an ancient concept dating back to before the 2000s when a company sells its products for more than the cost of making them and so gets to keep the balance rather than asking for more money from their Venture Capitalists. It’s out of fashion now with all the tech unicorns galloping around, but still very much alive in most established businesses. So anyway, companies make a profit and then must decide what to do with that profit. Depending on whether they are in growth mode or mature and stable, they either keep the profit and reinvest in growth and expansion or they give it to shareholders usually in the form of dividends. So dividends are cold, hard cash delivered directly to shareholders, and companies declaring dividends on a regular basis are usually mature, established, profitable, and growing at a slow, steady rate year on year. By the way, a few companies also allow you to accept dividends in the form of additional shares, but that’s not very common so we’ll ignore that for today.

Dividends are usually paid on a company-decided schedule, often quarterly but it could be semi-annual or annual or, rarely, even monthly. And sometimes, if the company is feeling generous or has done exceptionally well, they might announce special dividends on an ad-hoc basis.

So how it works is that the company decides a dividend amount per share and declares that to the public on what is called the announcement date. They’d also set a payment date on which the amount will be sent out either as a direct bank transfer or as checks or other mechanisms allowable in your country. For example, company X might announce that they will pay a dividend of 10 cents per share for the quarter, to be paid on the 20th of October.

Now let’s look at why I think dividend stocks are a great addition to most portfolios.

First, the reason why we are here. Dividends are the OG of passive income. Forget making Youtube videos and drop-shipping collapsable silicone cups on Shopee or hosting Tupperware parties. And delete all those SMSes from Bob promising to make you $3000 monthly guaranteed working from home. Just spend a few minutes investing all that money into a few reliable dividend stocks at a good price and go to bed already.

Companies with a history of dividends rarely cut them because they are really scared their shares will tank immediately. In fact, some so-called Dividend Aristocrats in the US stock market have a track record of paying steady and in fact, increasing dividends for decades. So if you choose well you should expect to receive a pretty steady income.

And speaking of dividends increasing, they also offer a form of inflation protection as the dividend increases usually keep up with inflation over time. So you don’t necessarily have to invest in Bitcoin just to keep up with rising expenses.

Finally, dividend stocks are of course stocks and hence can offer growth in your investment as well as passive income. The very fact that they are able to pay out dividends means they are profitable and cash-rich, which makes them more stable and potentially more desirable in downturns than growth stocks that are valued on future prospects. If you are able to buy in at a great price, you’d get the combined benefit of annual income as well as capital appreciation.

And depending on your income needs, you could select stocks with strong current dividend yields so you make good money right now. Just make sure the returns are sustainable or you’ll end up in what’s called a dividend trap, picking a dud that looks good on the surface but has shaky financials. Alternately if you don’t need money now but you expect to need it later, you could also pick those with smaller yields today but which are likely to increase their yield a few years hence so you get the benefit of a higher income in the future. How you pick companies like that needs further discussion so we will save it for a future episode.

But as with all things in life, everything isn’t roses and honey either. There are downsides to dividends

First, dividends are not guaranteed. In exceptional situations like Covid, they can be cut and afterward, management might decide to maintain the lower dividend payout in order to build up cash reserves for the future. If you are relying heavily on your passive income eg for retirement then such cuts will definitely impact your quality of life. Worse, dividend cuts will also result in a drop in the stock price as people re-calculate the ROI of the stock which will also reduce the value of your investment. In addition, a minor point is that dividends are usually not paid monthly so if you need monthly income then dividends might not work for you.

Second, dividend stocks do not fully capture the power of compounded growth. Because it is always paying out a portion of its profits, it does not make full use of the money at its disposal and is never able to capture the full stock price potential of its earnings. On the other hand, a growth stock with the same level of earnings retains and reinvests all its profits in itself, giving it a better chance of growing faster and hence a higher stock price. So if you just want to maximise your portfolio value, dividend stocks may not be for you.

The third issue is around taxation. Dividends are usually taxed the same as income, unlike the gains you make from selling stocks, which are usually taxed as capital gains. Income taxes in most places are higher than capital gains taxes. So from a tax perspective, you might be better off investing in growth stocks rather than dividend stocks, but of course, this is a moot point if what you need is income.

That’s it for today folks. I hope you enjoyed the discussion and maybe at least some of you looking for passive income will explore dividend stocks instead.

Takeaways for today

1. Well-chosen dividend stocks can generate substantial and growing annual income with little to no effort, much more than the typical side hustle probably can.
2. They aren’t guaranteed and hence work best for those who are seeking income but aren’t heavily dependent on it.
3. You could select your strategy so as to maximise returns today, plan for income in the future or just get your thrills trading on dividend arbitrage.
4. But just watch out for dividend traps which you can spot with the checklist linked in the episode description and online.