What is Dividend Investing?

Some stocks lay little eggs made of money, every few months.

It's kind of miraculous! You log in to your brokerage account to find a little bit of cash sitting there that wasn't there yesterday. How does it happen?

Some companies return money to their shareholders, usually quarterly. Back in the old days, they used to mail you a check four times a year. These days, the cash magically shows up in your account.

This means you can use the money to buy more stocks - reinvest it - and the money that your money made will make money of its own.


But it doesn't end there.

You can reinvest that money, so that the money that your money's money made can make money too!!

Amazing! It can keep going like this into infinity, if you have enough time, and can refrain from spending it right away.

Here's an example:

Imagine you buy $1000 of Stock in Some Company, which has a 5% annual dividend which it pays out quarterly. Let's assume you reinvest the dividends immediately.

(For the sake of this example let's assume everything else is equal- so we're going to assume the stock price doesn't change, and we're going to pretend that it's commission free, which it usually isn't, and we're going to assume the company doesn't raise or lower its dividend. This is just a broad, broad beginner's example.)

Here's what happens when leave our investment alone, only adding in our dividends every quarter. By the end of year 10 our $1000 has begat $643.62.

Some Caveats:
- Companies aren't required to pay out dividends, even if they've always paid a dividend before. They can stop at any time. On the other hand, there are companies like P&G who have not just paid- but also raised- their dividend for 61 straight years. Take a peek at the Dividend Aristocrats to see a list of some historically reliable dividend payers.

-The stock price can go down. Then again, it can also go up. On the wide average it tends to lean towards up, but any one company in particular? Nobody knows, They could pull an Enron tomorrow, or be the next big thing.

-When a company pays a dividend, you owe taxes on that income (unless it's in some tax-free or deferred account) the year it gets paid out. Other investing styles give you more control over when you pay taxes. The bright side is that certain dividends are taxed favorably compared to other income sources.

-When a company pays you a dividend, it means they're using cash to pay you that they could be using to grow the company, which can be argued affects its stock price. You'll notice that it's mostly large, mature companies who pay the most stable dividends.

-Brokerage fees will take a chunk out every time you buy or sell. These fees tend to be flat (my Scottrade charges $7 per trade), so if you double your investment, you halve your fee, percentagewise. This is why you shouldn't trade small amounts.

Think of it like buying a fountain soda at a restaurant where refills are free. If you buy one soda, it's $2.50. If you drink two sodas, they're $1.25 each. Drink five sodas and they're 50 cents a pop- let's hope this restaurant has a bathroom!

Since the price of soda remains flat no matter how much you drink, you can change the per-soda price by buying more soda in one sitting. Commissions on stock trades work the same way.

Dividend Investing's Unique Positives

- Whether the market goes up or down, you still get paid, as long as no one cuts their dividend. Buying during market downturns even helps to push your dividend yield percentage up.

- Since many companies pay out once a quarter, all it takes is buying three stocks and you get a paycheck once a month. This is really satisfying. Buy more dividend stocks and you can watch your money trickle in weekly. John D Rockefeller used to say "Do you know the only thing that gives me pleasure? It's to see my dividends coming in."

If that's the only thing that gives you pleasure, there's probably something wrong with you, but waking up in the morning and checking your brokerage account to find some new cash sitting in there really is a great feeling.

No comments:

Post a Comment