If you've been reading these articles for a while, you likely already know the basics of investing.

Long term success as an investor doesn’t need to be complicated. But it’s also easier said than done. And you’ve probably realised by now (as we all do) that the sharemarket is more of a mental game than you first thought.

A few things have the ability to throw us off course, mentally speaking. Bad news, recessions, falling share prices, and so on.

But what if there was something else you could focus on? Something that gave you positive reinforcement during the good times, and soothing comfort in the lean times?

Well, there is: dividends! In this article, I’ll explain why I think dividends are such a useful feedback mechanism when investing. I’ll also detail how they make owning shares a more enjoyable experience.

The two sides of investment returns

There are countless places where we can park our money these days. But I wouldn’t consider all of them to be true ‘investment’ assets.

Arguably, a true investment is one that provides both capital growth and income. Some things either provide only capital growth (often speculative) or an income stream. Cash, gold, and crypto fit in this basket. There are arguments against this view of what’s a true ‘investment’ and what's not, which I’ve addressed in detail here if you're interested.

On the other hand, asset classes such as shares and real estate provide both capital growth and income. Each one typically increases in value over time and provides rental or dividend income.

Let’s be clear: both growth and income are important. They also combine to make up your total return as an investor, so we shouldn’t disregard either one.

All investments sit on a spectrum. Some provide more growth and less income, while others generate more income with less growth. You’ll probably know people who focus on one over the other.

The assets you choose could be based on many things: your desire for simplicity or complexity, your personal tax rate, your preference for income or growth, your risk tolerance, what you have the most conviction in, and so on.

With that out of the way, let me explain why I’m such a fan of dividends in shares investing. Then I’ll explain common misconceptions and important points to remember.

Why I’m a fan of dividends

Firstly, if we own a diversified portfolio of income-producing shares, this is an effortless income stream.

Better yet, this income stays with us permanently. It also grows over time as companies become more profitable and reward shareholders with higher dividends.

As an investor, this helps me step back from the markets and focus on what I’m really doing: owning a slice of profitable, cash-generating businesses. This regular income stream provides funds to reinvest into more shares or rebalance a portfolio without selling.

Another thing - the more shares I own, the bigger my dividends become. That’s about the best positive feedback loop I could ever imagine, and a great encouragement to keep investing.

Dividends are also a source of return that’s not reliant on the market’s mood. This one is very important. Prices move up and down every single day. But dividends give you something more consistent and tangible to focus on - real cash hitting the bank account.

This is fantastic reinforcement for those who are just getting started in the sharemarket. This is especially important because shares don’t feel ‘real’ like property does.

And even if the market takes a tumble and has a crappy year (as it did in 2022) investors in things like index funds can still receive a positive income stream every single quarter. This allows them to sit back and relax, while the price-watchers are panicking.

It’s the same in retirement. The market can go all over the place, but there can still be dividends hitting the bank account. Granted, dividends naturally go down during a recession, but this creates a forced flexibility for those living off dividends.

While this can be seen as a downside, it also ensures your portfolio won’t hit zero (because you’re not selling). This brings great psychological comfort to many investors. We can discuss the different ways to live off a portfolio in a future article, along with how to deal with downturns in retirement.

I could continue, but I think you get the idea by now. Dividends are a fantastic feature of investing in the share market, and a useful metric to track. With that said, there are some important things to remember.

Don’t chase yield

When investors become enthusiastic about dividends, they sometimes start doing silly things. One such thing is trying to find shares with the highest possible dividend yield. They assume the one with the highest yield is best because it produces (or appears to produce) the highest dividends. Wrong.

Quite often, shares with very high dividend yields (over 8%) are unsustainable. Here’s why: the reason a ‘yield’ looks that high is because the price has recently fallen heavily.

For example, let’s say a company trades at $20 per share. In the last 12 months, it paid dividends amounting $1 per share (5% yield). Then, the company announces it's facing some serious problems in their industry that could hurt future profits. Shares fall to $10.

The dividend yield now appears to be 10%. But if profits are impacted as expected, it’s unlikely the company will continue paying the same dividends. At this point, the yield is likely an illusion. This sequence of events regularly catches unwitting investors who look solely at this one metric.

Growth matters

More valuable than a high dividend today is a dividend which grows over time. As an investor, you want assets which give you increasing income over time. Investments that shower you with growing amounts of cash over the next 10, 20, 30 years.

This is what makes shares (and property for that matter) unique assets. Not only do they grow in value and provide income, but they generate larger levels of cashflow as time goes on. And that’s crucial, because it ensures that when we’re living off investments, our income grows to keep up with inflation.

If your asset’s income doesn’t increase over time, it probably indicates it’s not a great long term investment. In other words, you want assets with a growth component.

The funny thing is, property and shares grow in value over time largely because of the underlying income. Profits and dividends grow, making shares more valuable. Rents and wages similarly grow over time, which makes property fundamentally more valuable and pushes prices higher.

None of this means you ignore capital growth when investing or managing a portfolio. What I’m talking about is more of a subtle mindset shift.

Instead of constantly looking at the value of your portfolio to measure its success, consider the income it’s spitting out. In fact, you may even enjoy tracking this metric so much that you check your investing account less and less.

Dividends as a motivational tool

If you focus on investing consistently into a diversified portfolio of income-producing shares, here’s what happens.

• Each time you invest, your annual dividend income goes up
• Each time you reinvest your dividends, your annual dividend income goes up
• Each time companies increase their dividends, your annual dividend income goes up

In every case, your investment cashflow grows and brings you closer to financial freedom. That’s pretty damn motivating if you ask me! When measured this way, progress starts to feel much more predictable and dependable, which encourages you to keep going.

And let me be clear: this doesn’t mean you change your investments in any way. It simply means you change the way you think about your investments.

So, if you find that share price moves make you a bit uncomfortable, shift what you pay attention to. Begin focusing on your dividends coming in each quarter and each year, instead of the current ‘value’ of your shares. It’s another great way to tune out the noise and focus on the big picture.

Final thoughts

Dividends are an effective way to measure your progress and success as a long term investor. In my view, it’s even more important than your percentage returns in a given year.

Why? Well, earning a 50% return in 12 months doesn’t really mean anything by itself. But earning $50,000 in passive dividend income? That means something.

So, if you find yourself checking your portfolio for the 10th time this week, consider what’s happening behind the scenes. Real companies, making real profits, paying very real cash dividends to shareholders.

Because at the end of the day, earning dividends is more fun than earning a paycheck.

Until next time, happy long term investing!