When it comes to investing in dividend-paying shares, patience and discipline are important
I am what you might call an unashamed income investor. I wasn't always a dividend investor, though. Like most people who first start out investing, I tried a bit of this and a bit of that.
I also made a few mistakes along the way. But mistakes are part of the learning process. No one ever gets it right the first time.
Over the years, I started to find that increasingly, more of my portfolio was being populated by income shares. I was, perhaps unknowingly, leaning towards dividend investing. Today, my portfolio is made up disproportionately of dividend-paying shares.
Choosing income shares is now a conscious decision because those are the types of shares that I am most comfortable owning.
To be a good income investor requires both patience and discipline. That is not to say that there are any magic formulas which when applied religiously will always guarantee success. But over the last two decades or so, I have found that doing certain things and avoiding doing others can help me achieve my goal.
Here, then, is my checklist of the dos and don'ts when investing for income.
DON'T CHECK YOUR SHARES TOO OFTEN
It is easy to fall into the trap of looking to see how your portfolio is doing by regularly monitoring the share price. Some people might even do it daily, if not more often.
But checking prices on a daily basis when you're investing for the long term is like planting a seed and inspecting it every hour.
Don't do it.
DO MAKE A PLAN AND DON'T TINKER WITH IT
To take my earlier horticultural analogy a step further, investing is a bit like starting a garden. You can end up with a messy patch if you buy whatever catches your eye and plonk it straight into the ground. Gardens need planning.
Similarly, a proper investing plan should consider how dividend shares interact with each other. Knowing what you need and what you don't helps you to seize on the most suitable deals, and not just any deal.
DON'T ANCHOR ON THE PRICE YOU PAID FOR A SHARE
Your focus should be on the dividends that you receive from your investment. If the dividend stream is not only intact but also growing, then your investment should be doing fine. The prevailing market price is arbitrary to everyone but you.
DO CONSIDER MAKING ADJUSTMENTS TO THE DIVIDEND-COVER IN RELATION TO THE RISKINESS OF THE BUSINESS
Generally, the dividends of a safe business should be covered about 11/2 times by profits. But for companies with less predictable earnings, the dividends should be covered more than twice by profits. To be even safer, use free cash flow instead of profits because cash doesn't lie.
DON'T FOCUS ON THE SHARES THAT EVERYONE ELSE IS TARGETING
It is tempting to buy shares in companies just because everyone is talking about them. But if everyone is talking about them, then the "stories" behind these companies are likely to be well known.
Consequently, their share prices are likely to be high. The time to buy is when companies are out of favour. That is when the shares are more likely to trade at attractive prices for the long-term income investor.
DO TRY TO LOOK INTO THE FUTURE RATHER THAN FOCUS ON THE PRESENT
A 2 per cent yield becomes a 5 per cent yield in five years, if dividends can grow at 20 per cent a year, assuming a constant share price.
Thankfully, the share prices of companies that are seeing a fast payout growth can often move higher. Income and growth can be joined at the hip, if you can find dividend-paying shares with strong growth potential.
DON'T FOCUS SOLELY ON THE YIELD
It can be a mistake to go for the highest-yielding shares, especially those that yield significantly more than the market average. Remember, there are no free lunches in investing. So try not to be too greedy.
Instead, look for companies that may not have eye-popping yields but have reliable yields that do not depend on strong economic growth. There are lots of examples of those types of companies in the Singapore market, especially in the Straits Times Index.
DO THINK OF YOURSELF AS A CAPITAL ALLOCATOR
There is no law that says you have to re-invest dividends into the companies that paid them. Sometimes it can make sense to do so. But if you feel that another share in your portfolio is better priced, then consider diverting one company's payout to top up a position in another.
You might even find that a share outside of your existing portfolio looks attractive. One of Warren Buffett's greatest strengths has been his ability to allocate capital effectively. As an income investor, you could be one too.
•The writer is chief executive officer of The Motley Fool Singapore.
A version of this article appeared in the print edition of The Sunday Times on July 31, 2016, with the headline 'The dos and don'ts of income investing'. Print Edition | Subscribe
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