People often spend a ton of time researching how to invest their money. I’m by no means a licensed professional, but I do know enough that I don’t think you should waste your money on a financial adviser. There are plenty of online tools available that can help you figure out your appropriate investment allocation, like the Motley Fool stock advisor review which is a great resource for picking winners. Regardless of how well you diversify your portfolio, I truly believe that dividend paying stocks are the way to go. I read an article years ago, when I was deep in debt, about a guy who had retired and had invested a ton of money into dividend stocks and he was no living off the dividend payments alone. Depending on your lifestyle that could add up to big bucks that you need to invest in these types of stocks, but it is certainly possible to achieve.
I’ve been steadily investing in dividend stocks for about 6 years now, even before I started getting my financial shit together. I’ve mentioned previously about my online brokerage account, and this is where I do a good portion of my dividend investments. I also have a 401k through my employer and I invest in dividend stocks there as well, but I am in one of those target date retirement funds so I have little say in which specific stocks and funds my money is invested. Whereas with my brokerage account I hand pick each individual stock and mutual fund I purchase. Keep in mind that I don’t purchase ONLY dividend stocks, but they do make up a majority of my holdings. I don’t think I will ever attempt to live off dividends when I retire, but I do think they could provide some steady monthly income one day.
How I Choose My Dividend Stocks
There actually isn’t a huge science involved with how I choose my dividend stocks, but I do have a short list of criteria that each one must meet. There is a short list of companies that have increased their dividends every year for over 25 years straight. This doesn’t simply mean they just paid out dividends for 25 years, but rather they have increased the amount paid every year for that period of time. In some cases these stocks have increased their dividends more than just one time a year, and sometimes by double digit percentages. You will find that these are often mature companies that are viewed as slow growth, and they use their stability and dividend payments to keep their stock shares attractive. Two such companies that I have been investing in from the very start are Johnson & Johnson and ADP. Both companies have attractive dividends, they continuously increase those dividends, and they have rock solid financials to boot!
While dividends are essentially like a built in return, meaning you get an automatic return on your money invested, it does help if the stock prices appreciate as well. After all, this how all non-dividend investments increase in value. For example, ADP currently has a dividend yield of 2.3%. This means that if you own $1,000 worth of ADP stock that you will receive $23 in dividends from them each year…except that they actually pay out in quarterly installments which is nice. As you can see that 2.3% is MUCH higher than the sub-par amounts you earn from a measly bank account. However, it is the stock appreciate that gives you a nice kicker. Since I started investing in ADP 6 years ago, I have a 77% return on my investment. I know this because I just logged into my brokerage account and checked my life-to-date return. Since their dividends are 2.3% this obviously tells me that their stock price has skyrocketed over the past 6 years as well. Then there is the other crazy shit that happened like one of the divisions of ADP spinning off into its own company, CDK. Since I was already an ADP shareholder they issued me a few shares of this company as well. In the past year my gain on this stock is over 1,000%!!! Now before you get too excited let me just inform you that I don’t exactly have millions invested in here, but it still illustrates the impact of capital gains!
My last steadfast criteria is that I don’t invest in dividend stocks unless the yield is above 2%. Most are, but not all. The reason for this is that when you start going below 2% you get dangerously close to the returns that banks provide, either in the form of CD’s or money market accounts. Since there is no risk with those types of accounts it begins to make less sense investing in dividend stocks. If you want the highest yielding stocks those usually fall within one of two categories, REIT’s and sin stocks! A REIT is a real estate investment trust. They tend to pay a very high dividend yield, in fact some pay out double digit percentages. The catch is that some can be extremely risky. The only way they can entice investors is by paying out a very high yield. Most people think they tend to be safer these days based on the upward movement of the housing market, but I still remember the real estate crash a few years back and prefer to stay away from these stocks myself. Next up are the “sin stocks”. These are so aptly named because they usually involve alcohol or tobacco products. The big tobacco companies tend to be financially healthy, after all, they make products that are downright impossible to quit and give up. They also carry a very bad rap, and many people simply feel guilty investing in such a stock. These companies are well aware of this so they often have dividend yields north of 5%. This is a very high return on your investment that is all but guaranteed, which is why there are people out there willing to forgive the companies sins and they invest anyways. I personally don’t invest in these stocks, but I know many that do.
Stick with the DRIP
DRIP is an acronym that stands for Dividend Re-Investment Plan. Most online brokerages offer this feature free of cost, and it’s a big benefit. Because I’m not anywhere near retirement I am not withdrawing dividends from my account when they are paid out, rather I invest them right back into the companies themselves. In doing so you continue to compound and increase your holdings of those companies, which in turn increases your dividends as time goes on. Not to mention you aren’t on the hook for all the taxes that come along with taking distributions. The biggest benefit I get from DRIP’s is that I don’t pay a trade fee when I automatically reinvest those dividends. When you buy a stock you often times get saddled with a $6 trading fee, at least that’s what I pay in my account. Since I hold about 10 different dividends stocks that make quarterly payouts, that is 40 different dividend payments per year. If I had to pay $6 every time I reinvested those funds it would cost me an extra $240 every year.
Another huge benefit of a DRIP is that you can buy fractional shares of a stock. Allow me to explain. If the share price of a stock is $100 then it stands to reason that you need at least $100 to buy 1 share. If your quarterly dividends only amount to $50 in total, then a DRIP will buy you 0.5 shares. I have fractional shares of stocks of every company I own because of this. Based on my example above, after a full year of dividend payments you would have a couple of extra full shares of that stock.
How Much Do I Earn in Dividends Each Year?
I do invest in some non-dividend paying stocks, as I try to be well diversified, and I want to take advantage of investing into companies I believe will have high growth in the future. However, dividend stocks are the meat of my portfolio, and will continue to be well into my retirement. In 2014, I earned $2,000 in dividends, and that was just within my online brokerage account. I earned more dividends in my 401k plan, but as I said, I have little to no control over how those funds are invested other than the fact I chose the target date fund closest to my desired year of retirement. My short term goal is to earn $1,000 a month in dividends, and my long term goal is to make $2,500 each month from dividends, all within my personal brokerage account. To illustrate how lofty my short term goal is just take my full year earnings of $2,000 from dividends and divide by 12 months. This comes out to around $170 per month in dividend payments. If I was to increase this to $1,000 per month then I need to increase the current value of my dividend paying stocks to 6 times the amount I have now! Remember, I said I have been investing in them very slowly over the past several years so I will have to start picking up the pace a bit.
If you like what you see then own your own online brokerage account! They are a low cost and easy to manage option for people that want to get a nice return on their investment. I’ve included a couple of my favorites below.
TD Ameritrade is well known, and has a great online presence! They offer everything from a user-friendly mobile app, to an easy PC platform as well.
The other company I recommend is Trade King. They don’t have the brick and mortar presence that TD does, but then again, you don’t really need it either. What I like about Trade King is that they have better promotional offers, like their $200 new account bonus…If you don’t have an account already then they are the way to go.
This is exactly how we build up our portfolio, mostly dividend paying stocks. Diversified over sectors, geografical area’s and size of company. There are one or two things which I have learned over the last 20 years and which you haben’t mentioned:
By far the most important is that some brokerages are known to have their own Dividend reinvestment plans in addition to the DRIPs you mentioned. But their own plans are not paid by the company paying the dividends but by the customer. And usually it is easier to start their own reinvestment plan than the official DRIP. I used to have a broker where starting their own plan was exactly one click on the internet whereas participating in a DRIP for exactly the same stock required a phonecall and paper forms. Once I found this out I changed broker, obviously.
The other thing is that REITs can have complex tax-consequences which for most people are difficult to handle/solve without an advisor. And when investing in a REIT from outside the US, like I do, the tax one pays can be above 40%, and the amount of payable tax depends on the Broker! Inexperienced brokers just take a big tax-deduction from your dividend to cover there ass in case they mess up the tax.
But even more important than all: you forgot to mention the shear joy of receiving dividends. It really is money for doing nothing!
Hey SOT,
Dividends are definitely the way to go! Nice article and good choice in investment strategies. Dividend growth investing is an even more specific, full-proof strategy which will go a very long way when followed consistently.
Best regards
DB
Thanks I appreciate it!