Ask your advisor how your investments will increase your income stream
Patrick E. Gauthier
Pay yourself first. A feature of financial planning.
You’ve no doubt heard this advice and hopefully heeded it. Achieving your financial goals starts with paying yourself first. Save your money before you have a chance to spend it.
Are your investments doing this for you? Do they pay you regularly for the use of your capital?
You probably guessed it; we are talking about dividends. Dividends are the main way for companies to return capital to shareholders. They reward shareholders for the use of their capital and provide them with an income stream without having to sell their investment.
A history of steadily increasing dividends is a sign of a well-run company. The dividend policy is important for investors. A company that regularly increases its dividends is considered healthy. Whereas a company that lowers dividends could be in trouble.
Can dividends withstand inflation? A stream of income is only as good as its purchasing power. Fortunately, we have history on our side.
LEARN MORE ABOUT YOUR MONEY:
The dividend growth rate of large US-based corporations has far outpaced inflation since the 1940s. Even here in 2022, where inflation is higher than we’ve seen in decades, dividend growth to date in the S&P 500 is about 10.64%, according to Standard & Poor’s.
It would not be a stretch to imagine companies wanting to use company money for other purposes. Families are certainly tightening their spending habits. This is the power of the dividend policy. Once it starts, businesses do everything in their power to keep the revenue flowing.
Companies have another way to return profits to shareholders: share buybacks. It is an effective tactic with growing popularity.
Redemptions work a little differently. Instead of sending money directly to shareholders, the company chooses to buy its own shares on the market. This serves to reward current shareholders with fewer total shares outstanding and a larger share of the business. Buybacks may also improve certain ratios used by analysts. For example, your earnings per share in the future are higher with fewer shares outstanding.
Stock buyback plans also tend to be more flexible for the company. They often have an allocated amount to spend over a specific period of time. They may or may not use all of the allocated dollars, and suspending buyout plans often comes with less fanfare than a dividend cut.
A combination of these tools is the preferred combination for most businesses. A firm commitment to dividend growth rewards shareholders. A well-structured redemption plan provides flexibility for capital without tying up future cash flows.
Your investment manager should share this commitment to consistent dividends and sound capital management. Ask your advisor how your investments will increase your income stream.
Patrick E. Gauthier is a Principal Portfolio Analyst for CPS Investment Advisors in Lakeland.