A lot of personal development experts emphasise the importance of habits. The idea is that the right habits are more likely to establish a pattern of behaviour. That can lead to better results. I think that’s true for me as an investor too. With the right investing habits, I reckon I can dramatically improve my results.
Here are three habits which, taken together, I hope could double the passive income I receive from my portfolio of dividend shares.
1. Double the money
What’s the easiest way to double my money from dividend shares?
I think the answer is obvious: double the money I invest. That sounds so obvious it hardly seems worth mentioning. But actually, the simple sounding step of doubling how much I invest could have transformative effects for the passive income I earn. With the potential of lower trading costs in percentage terms and the power of compounding, I may see more a doubling of output for a doubling of input.
There is some potential pain from investing more. If I am already investing as much each month as I can easily afford, it might not be easy to do without sacrificing some other expenditure. It might be possible, for example by trimming my living costs or cutting down on unnecessary frivolities. I’ll have to make some hard choices. In the long term, though, I think a much larger dividend portfolio will probably do me more good than years spent drinking overpriced coffees each day.
But a lot of people don’t invest anything like the most they can each month. If I was in such a situation, regularly investing £50 for example, I could start investing £100 each time instead. After a few months, I would likely adjust to the larger outgoing just like one adjusts to higher electricity bills or rising insurance premiums. But by putting twice as much money into dividend shares each month, I’d hope to get twice as much passive income.
2. Go for great
A lot of investors are happy to settle for what they regard as good shares. But that isn’t a habit of highly successful investors like Warren Buffett. Instead, they typically look for great companies. Indeed, Buffett says that he likes to buy great companies at good prices.
Over time, the difference between a great dividend paying company and a merely good one can dramatically transform results in one’s portfolio.
Great companies have business models which can can produce strong profits on a sustained basis. That can be due to competitive advantages such as iconic brands, proprietary technology, or geographic monopolies. That can allow them to pay out high dividends compared to other companies.
Consider as an example the difference between Smith & Nephew and GlaxoSmithKline. Both are well-established global companies in the healthcare sector. Both have strengths to their business including proprietary technology and strong brands. But Smith & Nephew is operating in a business area where such factors might not matter as much. Will doctors or nurses pay a premium for wound dressings? I reckon they will, but the case to do so is less compelling than it is for life-changing drugs of the sort GSK makes.
Smith & Nephew yields 2.2%. GSK offers a yield over twice as high, at 5%. GSK is planning to separate into two businesses and its yield may fall as a result. Nonetheless, right now, adding GSK to my portfolio would offer me over double the passive income I would get from adding Smith & Nephew. I like Smith & Nephew as a business and would happily hold it in my portfolio. But if passive income is my objective then I think there are better choices available to me.
That said, yield isn’t everything. What if a share is a yield trap? Such shares look attractive because of high dividends, but in the long term their business results can’t fund such dividends and they may be cut. That’s why it’s important for me to focus on what separates a great company from a merely good one. For example, when a company has a high yield but the dividend isn’t covered by free cash flow, that could be a red flag for me.
3. Do less
One mistake many investors make is trading too much. In fact, some of the best performing investors of all time trade only very rarely.
Consider builder Galliford Try as an example. Right now I could get a 2.6% yield by buying the shares. But if I’d bought the shares last October, I could have bought them at 40% of the price today. So I would now be looking at a yield on my initial investment of around 6.5%.
The point here is not to focus on market timing. I think that’s too hard to do successfully. My examples above rely on buying the shares at their price bottom, which is very hard to know (although I did explain last November why I would consider Galliford Try as a recovery play). Rather, it is about being willing to sit on the sidelines of the market, for years if necessary. Then, when a really great opportunity arrives, as an investor I can make the right move at the correct time.
It is no accident that Buffett sits on cash for years, even when it adds up to tens of billions of dollars. As Buffett says, “If you want to shoot rare, fast-moving elephants, you should always carry a loaded gun”. In other words, if I want to double my passive income, I may need to stockpile cash without buying shares, for years if necessary. Then, when I see the opportunity to buy a great company at a good price, I can make my move.
Putting investing habits to work
The theory is easy – how about the practice?
I don’t think it’s hard for me to apply any of the above investing habits. But the more ambivalent I am about them, the less likely I am to put them into action when I need to. That’s why habit formation matters so much – it helps me develop a way of behaving which becomes almost second nature.
That isn’t hard to do. But I think it could transform the passive income potential of my portfolio.
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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended GlaxoSmithKline and Smith & Nephew. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.