Real Estate Bubble and Misunderstood Dividends

David Kennon Kennon Financial

 

I am about to teach you how dividends react to stock market changes. The vast majority of people with whom I meet do not understand this important mathematical concept.

Let’s say you have a diversified portfolio of stocks and bonds. Some of the money you make is from dividends and interest. Some of the money you make is capital growth (the value of the stock or bond increases in value).

For example, the Coca-Cola Co. is currently paying around a 3% dividend. If you invest $100,000 into Coca-Cola stock, you will receive $3,000 in dividends during the year. Dividends are simply profits that companies give back to shareholders.

So, what happens if The Coca-Cola Co. has a huge drop in its share price? Let’s say it loses 30% for example.

If your $100,000 in stock is now worth $70,000, how much money will you receive each year in dividends going forward?

The dividends would be 30% less, right? You would only get around $2000 a year going forward, right?

Nope. You would continue to receive $3,000 a year*. How is that possible?

Let’s say you buy a rental property.  You pay $100,000 for the house and you start receiving $1,000/mo in rent. What happens if another real estate bubble bursts and the value goes down?  What happens if, when you go on Zillow to see the current value of your home, it says $70,000?

Do you start getting 30% less in rent?  No. The rent doesn’t change. The underlying asset may temporarily be worthless, but the rent doesn’t change.

This is an absolutely essential concept to understand. Why? Because it should help insulate you from fear about the markets.

Many diversified income-oriented portfolios in the current economy could pay around a 3% dividend on stocks, and around a 3% yield on bonds. So no matter what happens to the share price of your stocks and bonds, that 3% keeps getting paid out. It is a huge buffer in volatile markets.

Can companies decrease dividends? Sure, but it is much more common for them to increase dividends. And, don’t forget a diversified portfolio of stocks contains hundreds, if not thousands, of companies.

Last year dividends increased for U.S. stocks by 57%.  In fact, 53 stocks in the S&P 500 have increased dividends every year, for 25 years. The Coca-Cola Company has increased dividends every year for 55 years. These stocks are often referred to as the Dividend Aristocrats.

My point is this: regardless of share price, your cash flow continues. Dividends and interest are powerful tools for retirement income creation. It is not all about the share price.

And now you know!  And knowledge of power!

Be Blessed,

Dave Kennon, Kennon Financial