A couple of days ago new reader Samuck asked me why I bother with individual stocks when my ETFs seemed to be performing so much better, which you can clearly see in my latest net worth update. Although I’ve discussed my preference for dividend growth stocks in the past, I feel like his question touches opon a another point that’s often brought up: do I benchmark my dividend growth portfolio to an index and, if so, why?
Exchange-traded funds basically track an index that is made up of individual stocks that are selected following a pre-defined set of criteria like market capitalisation and regional diversification. So when Samuck was asking me how I felt about my individual stocks underperforming my ETF holdings, his question boiled down to whether I don’t mind that my stock picking underperformed the MSCI World, MSCI Europe, and MSCI Emerging Markets indices during the same time frame.
Of course, these indices are not as popular as the S&P500, which is often synonymous to “the market” for much of my Northern American readership, the Euro Stoxx 600, or the FTSE 100, but the principle remains the same. So is it wise for a dividend growth investor to benchmark the performance of his or her stocks to a popular index?
Before we can answer that question, we should take a quick look at what many a dividend growth investor, including myself, tries to achieve, especially within the framework of financial independence and early retirement. We are all building a stream of passive income by investing in high quality companies with a long history of providing excellent returns to shareholders through increasing dividend payments.
By doing so on a consistent basis, I have already amassed and secured future dividend income to the tune of €500 every single year. That’s a significant income bump simply because I trust and continue to believe in a couple of businesses! If you’re looking to become financially free, it’s key to build monthly passive income that surpasses your expenses, which is very easy to track using the dividend growth investing strategy.
Does it matter then if your investments didn’t beat a randomly weighted index of companies when building a consistent and reliable stream of dividends? Not at all! While I am highly certain that the companies I’m invested in will continue to forward me a piece of their profits in the form of cold hard cash, which I can use as I please, I can’t go to the grocey store to buy a loaf of bread or a carton of milk with a fun statistic like outperforming the stock market with a couple of percentage points.
Furthermore, comparing the performance of your dividend stocks to an index all the time might lead you to take on too much risk. Our brains are programmed to react emotionally when rational reasoning fails, after all. When “why didn’t I beat the market?” becomes the modus operandi of our investing strategy, chasing higher yields for the sake of higher yields is only a small step away, and that’s a very dangerous road to be on.
Even if the Euro Stoxx 600 benchmark outperformed my little portfolio every single year for the next two decades, I’d still be able to retire early or enjoy a financially free life. I’m saving and investing a large percentage of my paycheck every single month, which is what reaching financial independence ultimately is all about. Yes, a slightly lower return might have me working a month or two to three longer, but in the long-run that won’t matter in the slightest.
What is three months when you have a lifetime of free time to look forward to – time you can spend any way you want? I’m not going to lose one night’s sleep over that simply because I believe in my current investing strategy. Would you?