The difficult psychological aspect of a dividend-based strategy

Many investors focus exclusively on stocks that pay the best dividends. They spend countless hours to analyze companies, study balance sheets and improve their admission criteria. Yet when these companies, which they have taken so much trouble to identify, see their share price appreciate, they decide to cash in and move on. Unfortunately, in most cases they end up worse off with their new idea than if they had simply kept their titles.

Human beings very often tend to want to do too much. It's as if, to justify their existence, they had to prove to themselves that their work is useful. However, in the stock market, and especially when it comes to dividends, it is preferable in most cases to do nothing. The best is the enemy of the good! We're talking about passive income, it means what it means...

I am always fascinated by investors who are quick to pull the trigger on the gains they generate, while not even caring when companies cut or stop paying dividends. Do you leave your employer because they are making too much profit? Worse, do you stay when they stop paying you? It’s the same thing! 

Winners tend to always win, while losers tend to always lose. Companies that regularly increase their dividends have a very high probability of continuing their streak. Conversely, those that reduce or eliminate their distributions are rarely good investments for the long term investor, even if they ultimately decide to return to dividend growth.

What I'm trying to describe here is that dividend investing is very difficult, not from a technical standpoint, but from an emotional standpoint.A significant part of the investment equation is indeed investor psychology. Even if they are smart enough to have selected the best stocks on the planet at the right price, they can still end up not making money, or worse, losing it.

Investors who bought at a good price can't go wrong with holding on to dividends that are growing over the long term. The dividend trend is their friend. Unfortunately, psychologically speaking, it is very difficult to hold on to a winning position. A position that climbs to 50%, 100%, 200% and even higher over a period of months to years or even decades would make most investors nervous. This would be the case even if the underlying fundamentals were still intact, and if the upward trend in earnings and dividends were to continue in the future.

Dividend investing poses another psychological problem. Since it is a slow process of wealth creation, based on passive income, it must be stuck with for a decade or more. Few investors have the tenacity to stick with a single investment strategy for such a long period of time. People tend to give up easily when they face certain difficulties. It is very difficult to confront a long-term dividend-based approach with the desire to obtain rapid wealth as some investors might have done with, for example, volatile technology stocks in the past.

Those who decide to take shortcuts to reach their target may end up disappointed. Some of these shortcuts include excessive leverage or the use of options and futures contracts that could lead to huge investment losses even during a small market correction. Another shortcut would be to seek out high-yielding companies like real estate investment trusts, such as American Capital Agency (AGNC) or Annaly Capital (NLY). If short-term interest rates start rising faster than long-term interest rates, the distributions of these companies would be at risk.

The dilemma is obvious to those who have bought stocks that have increased their distributions for several years. We learned (wrongly) in school or at work that inactivity does not make you rich. As a result, many investors end up selling winning stocks, realizing their gains, but in doing so they limit their future upside potential. Unfortunately, dividend investing is sometimes counterintuitive, and it takes several years of positive reinforcement to become aware of this.

Source: http://www.dividendgrowthinvestor.com/2012/09/the-most-challenging-aspect-of-dividend.html