How to Beat the Market with a Do Nothing Strategy
Do Nothing investing means buying high-quality businesses and then holding them for the long-run.
Most people think of the Do Nothing investing strategy as simply buy-and-hold. That’s a big part of it but it goes way beyond. The real surprise of this strategy is its ability to build up your dividend income over time.
There are many reasons why this is true. But don’t take our advice at face value. We’re happy to provide evidence.
Warren Buffett, the best investor in the world today, has said the following about one of his favorite investing strategy:
When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.
This quote makes it very clear that Buffett is a Do Nothing investor under the right circumstances.
Buffett’s success aside, there are fundamental reasons why Do Nothing investing works. This post will describe three ways that Do Nothing investing can build up your dividend income over time.
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Do Nothing Method #1: Dividend Growth
The first way that Do Nothing investing can build up your dividend income over time is through organic dividend growth. Some companies have a remarkable ability to grow their dividends over time. Identifying and investing in these companies for the long run is one of the most actionable ways that Do Nothing investing can build up your dividend income over time.
The Dividend Aristocrats are the best example of this, and are often considered to be one of the best groups of dividend growth stocks in the United States. To be a Dividend Aristocrat, a company must have increased its dividend each year for 25 consecutive years.
This is very selective cutoff, so there are few Dividend Aristocrats. Still, their track record of steady dividend increases means that Do Nothing investing aligns almost perfectly with the Dividend Aristocrats.
For investors who aren’t focused exclusively on rising dividend income, the Dividend Aristocrats are still attractive because their total returns have also been very strong. The graphic below from S&P Factsheet compares the performance of the Dividend Aristocrats to the performance of the broader S&P 500 Index over the past decade.
The Dividend Aristocrats have delivered annualized returns of 11.6% over the past decade while the broader S&P 500 Index has returned 8.3% per year. In other words, the Dividend Aristocrats have outperformed the S&P 500 by an average of more than 3% per year for ten years. This is remarkable outperformance, especially considering the length of time that the performance is being sampled from.
To sum up, the consistency of the Dividend Aristocrats means that these stocks are likely to generate more income over time even if you contribute no additional funds to your investment portfolio – which is Do Nothing investing at its finest.
This effect becomes even more powerful when combined with an appropriate dividend reinvestment strategy, which is the topic of the next section of this article.
Do Nothing Method #2: Dividend Reinvestment
Do Nothing investing is far more focused on selling (or rather, not selling), than it is on buying. By not selling stocks due to short-term volatility or business uncertainty, you can take advantage of compound interest, legally defer capital gains taxes, and focus on finding your next great investment opportunity.
So Do Nothing investors tend to avoid selling. The same cannot be said for buying. Despite the strategy’s name, even Do Nothing investors will be buying stocks as time passes.
There are two sources of additional funds that investors need to deploy: dividend payments and new contributions to your investment portfolio (usually generated from employment income). We’ve seen already that Do Nothing investing allows you to take advantage of organic dividend growth over time. This section will discuss how to properly reinvest these dividends to maximize your dividend income over the long run.
There are two ways to reinvest dividends. The first is automatic reinvestment through a program called a “Dividend Reinvestment Plan,” or DRIP for short. DRIPs automatically reinvest dividend payments back into the companies that paid the dividend, with the remainder delivered as cash.
For an example of a dividend reinvestment plan, we’ll use Johnson & Johnson (JNJ). If your Johnson & Johnson stock paid you a $120 dividend and their shares were currently priced at $50, you would receive two new Johnson & Johnson shares as well as $20 in cash.
Dividend reinvestment plans seem attractive on the surface because they help to automate your investing strategy. This aligns with the principles behind Do Nothing investing.
Still, dividend reinvestment plans are flawed because they take money away from your best investment opportunity to reinvest dividends back into the companies that originally paid them. Often, these companies aren’t attractive anymore because their valuations have changed since you originally invested in their stock.
The alternative to dividend reinvestment plans is selective reinvestment. Using this strategy, you pool your dividend payments until you have enough capital accumulated to initiate a new position or make a meaningful increase to an existing position.
We believe that selective reinvestment is far superior to automatic reinvestment because it allows you to double down on your most compelling opportunities instead of automatically reinvesting dividend payments into stocks whose prices are no longer attractive relative to their underlying earnings power.
For income-oriented investors, selective reinvestment is similarly attractive because it allows you to opportunistically buy shares of companies with higher yields – generating more dividend income in the process. Repeating this process along with a long-term, buy-and-hold Do Nothing investing strategy will slowly but surely generate meaningful income over time.
Why Investing in Dividends is Great for Your Portfolio
Investing in dividends is a great way to add some extra income and diversity to your portfolio. It can help you avoid the volatility of the stock market and provide better returns over time. Dividend investing can also help you meet your long term goals such as retirement or college savings.
Investing in dividends can also provide you with another very important benefit: stability. If you invest solely in the stock market, you are relying on its performance and long term growth potential to give you returns that will help meet your investment goals. You may be subject to short term volatility where the prices of your stocks go up and down a great deal, which can cause you to lose money. Dividend paying stocks, on the other hand, are much more stable and have a tendency to rise in price over time. This makes them a great option for investors looking for stability and consistent returns.
Another thing to keep in mind with dividend investing is that you will need money upfront to buy stocks. You can’t invest on margin or borrow from stock brokers, so be prepared to have any required cash ready when buying these types of investments.
It’s also important to remember that all dividends paid out of company profits will be taxed at normal income tax rates unless they were issued by a corporation that qualifies as a “qualified foreign corporation”. In this case the dividends would not be subject to state or federal taxation, although they may still fall under some local city taxes depending on where you live.
Dividend Investing is a great way to add some extra income and diversity to your portfolio. By investing in stable, dividend paying stocks you can avoid the volatility of the stock market while still earning consistent returns. If you’re interested in getting started, be sure to do your research and talk to a financial advisor to find the best options for you.
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Do Nothing Method #3: Psychological Advantages
The greatest benefit to Do Nothing investing is it eliminates many of the emotional mistakes that investors succumb to which reduce their long-term total returns.
The most common mistake that investors make is selling at the wrong time. Do Nothing investing eliminates this possibility by definition because it entails buying stocks with the intention to hold them for the decades to come.
This is easy to write about but difficult in practice. We have two pieces of advice to help you successfully implement a Do Nothing investing strategy.
Our first advice is to invest in businesses with tremendous staying power. There is no greater example of this than Coca-Cola (KO). The company has been in operation since the late 1800s, and its core product (cola syrups and concentrates) has remained essentially unchanged during this time period. Moreover, Coca-Cola’s business is likely to remain unchanged for the years to come.
Despite its slow-changing business model, the company has delivered amazing shareholder returns because of its capital-light business model and exceptional brand recognition. Coca-Cola is a textbook example of a business with staying power, which is exactly what the Do Nothing investor should look for when analyzing investment opportunities.
Our second piece of advice is to remember that stocks are not just pieces of paper to be traded back and forth. Instead, stocks represent an actual ownership of some underlying business. Whether it’s Wal-Mart (WMT) or McDonald’s (MCD) stock, your shares mean you own a part of a business that has a very high likelihood of being around for the decades to come.
The psychological benefits of Do Nothing investing are hard to overstate, and allow investors to avoid the mistake of selling at the wrong time. This helps to maximize your dividend income over the long run.
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Final Thoughts on Do Nothing Investing
Do Nothing investing is very attractive because it allows investors to generate rising dividend income without any additional work. It also requires less work – after your initial purchase has been made, you can sit back and wait for long-term dividend growth.
The big money is not in the buying and the selling…but in the waiting.
– Charlie Munger, Vice Chair of Berkshire Hathaway
The next time you’re tempted to sell a security due to short-term price volatility or business uncertainty, remember the points we’ve laid out in this article. Do Nothing investing is unique in its ability to improve returns with no additional work, and selling stocks eliminates these benefits entirely.
This is a guest contribution from Nick McCullum at Sure Dividend. Sure Dividend uses The 8 Rules of Dividend Investing to systematically identify the best high quality dividend growth stocks for the long-run.
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