Why Dividends Are The Key To An Early Retirement

Here’s why you should think about income before all else when investing your hard-earned cash

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

I doubt there are many people reading this who do not wish to retire early. In fact, it’s one of the most popular goals among people of all working ages: to spend your days doing whatever you like, while safe in the knowledge that you have sufficient capital to live out your days in comfort and abundance.

Of course, it is a noble aim, but achieving it can be much more difficult than many people imagine. However, by focusing on the dividends from your investments, you can get there much quicker, and in a simpler and more straightforward way than you may currently realise.

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Financial Health

While there are different life stages to all companies, dividends usually indicate that a company has sound finances. Of course, a start-up is unlikely to pay dividends, while a company that is a number of years old but which is enjoying rapid growth is also more likely to reinvest profit to achieve an even higher rate of growth.

However, for the majority of listed companies, neither of these situations is the reality, and so dividends are an effective means for investors to ascertain whether the company is performing well at the present time, since a generous, growing dividend indicates that it is delivering upbeat returns and is able to afford to share its success with investors.

Valuation

Dividends are also an effective means of valuing a company. In other words, if a company’s shares offer a relatively high dividend yield then it could indicate they are trading at a relatively low price and may offer strong capital gains over the medium to long term. Of course, it could be the case that the company is paying out all of its profit as a dividend, and thereby increasing its yield. This is not sustainable without significant earnings growth, but may be acceptable in the short run if earnings growth is expected to pick up.

Confidence

Furthermore, dividends also indicate management’s confidence in the future of the business. If they see problems ahead, dividends may be cut, while a bright future may encourage management to increase dividends at a rapid rate. As such, a company’s track record of dividend increases, as well as its guidance on dividend growth/dividend policy, could help investors to identify a stock with a bright future.

Total Return

In addition to the above, a number of studies have shown that dividends make up a sizeable portion of investment returns over the long run. Furthermore, it is the reinvestment of dividends that makes a major impact on your total returns over a long period, thereby helping you to retire early.

So, while it may not always be possible to invest solely in stocks with high yields, dividends could prove to be the most worthwhile way to reach your goal. And, of course, once you get there, they can provide you with a superb income through which to enjoy your well-deserved retirement.

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