For those of us looking for supplemental cash flows from our investments, the question of how to best achieve this is an important one.
Do we sell those shares that have outperformed and take the capital gain as a lump-sum cash inflow? Or do we hold on and continue to collect monthly or quarterly dividend income? Do we want to be opportunistic and monetize gains when we have the opportunity to do so? Or do we want a regular and reliable stream of dividend income for the benefits of long-term investing and compounding?
Let’s take a look.
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Compounding in action: A regular stream of growing dividends
Dividend income that is reliable, well-covered, safe, and growing is really the safest route to generating cash flows. A stock like Fortis Inc. (TSX: FTS) is a good example of this. Currently, Fortis shares have a dividend yield of 5.9%. This dividend stock has performed exceptionally well over the long run, and this shows in its track record.
This dividend income, or cash flow generation, has been reliable, predictable, and low-risk for investors. It came in the good times and the bad. It was resilient. And reinvesting it compounds the returns over the long term.
Selling shares monetizes gains and provides a one-time boost to cash flows
Building a portfolio of stocks for dividend income is the best way to set yourself up for regular cash flow payments well into the future. Selling shares is a less predictable strategy, as stock price movements are way less predictable than dividend payments.
Yet sometimes, selling shares can be a smart move to capture extra cash flows. For example, maybe you think a stock and/or the market is trading in bubble territory. In this case, selling at least some of your shares takes advantage of high valuations and pockets some of the gains. This cash flow can then be reinvested into a cheaper alternative. In the end, one can theoretically achieve strong returns in this scenario.
But it is the riskier strategy, as we have now just introduced reinvestment and market timing risks. Going back to Fortis stock, as you can see from its stock price graph below, its long-term performance has been very strong. So holding on to the stock and collecting Fortis’ growing dividend was the best move.
As a believer in finding the right companies and investing in them with a long-term horizon in mind, this strategy leaves me with a hint of discomfort. It asks investors to make market timing decisions and trades that are actually very easy to get wrong.
The bottom line
At the end of the day, as with most things in life, there is a lot of gray, or nuance, in the answer to this question. This means that the answer to this question depends. It depends on opportunity cost, and of course, it depends on risk tolerance and needs and goals.
But generally, for long-term investors, dividend income is the way to go for cash flow generation.
