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Ultimate Dividend Investing Guide

       Dividend investing is all about building a passive income stream or dividend income. These types of investors are also known as income investors. People often ask what are the best dividend stocks or what are high dividend stocks? What about monthly dividend stocks? These are all great questions. Let's dive in!

 

          It's no surprise that Dividend Investing Strategy is my chosen and favorite type of investing. My Twitter handle is Dr. Dividend for reason. I've got a PhD in dividend investing, no not really, but I've done 1000's of hours of research on the topics and 1000's more building my custom Dividend Growth Portfolio. I grew up in Indiana my whole life until I joined the military. My Dad was a plumber and my mom was a janitor their entire lives. It's safe to say that money was a struggle, and my parents didn't budget. My dad would grind away his entire life with, unfortunately, nothing to show for it. I remember seeing stacks of bills and late notices at a young age. Had my dad lived to retirement age he would have would for decades with the only light at the end of tunnel being social security. A small payment each for YEARS of bone biting, soul crushing work. Most of the population will do the same thing, work for four decades or more in the hope they can retire one day. It's time to break that cycle.

          Fast forward to 2007 when I joined the Navy. They gave me paperwork to sign up for the "Thrift Savings Plan". I did but had no idea what it was other than I was allocating money to a retirement account. I wanted to retire so it sound like a good idea.

me prior to bootcamp
Me on deployment

Prior to boot camp (left) and on my first deployment (right)

          It wasn't until I was 25 that I really starting "falling off the deep end" and started learning about investing and financial literacy. I quickly realized that school had done next to nothing to prepare me for real life when it came to my finances. I was armed with two goals, I wanted to retire as early as possible and I was going to learn as much as possible to make that happen. I'm currently on track to retire around age 45. Not bad, but I could have done better if I had started learning sooner. It's NEVER to late and there isn't such thing as to small of an investment. Let's dispel those rumors now. I've spent that 16 years in the military as a Financial Specialist. This is a job where they give your specialized training and reoccurring training you teach members at your Command about budgeting, home buying, car buying, investing, and other financial topics. I've personally trained 1000's of people how to invest across nearly two decades. Let's get you started on your investing journey as well! Check out my dividend stock tutorial below! 

Happy Investing!

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Table of Contents

What is dividend investing?

          Dividend growth investing is an investment strategy that seeks to invest in companies with high-quality dividends. Dividends are payments made by a company to its shareholders, usually on an annual basis. Dividend growth investing does not require active trading or any timing of entry and exit points; it's all about the long game! The goal is to build a passive income stream from dividends that you can use during retirement.

 

          Typical long-term investing strategies include selling portions of your portfolio each month or year to generate money during your retirement years. You may sell 3-4% each year and live off your portfolio for years, but what if the market falls significantly? Dividend investing is used to help you answer that question. Consider earning 3-4% per year and never having to sell a single share. Imagine creating a portfolio that could last a lifetime by adding up all of your dividend earnings from prior periods. Your children could also benefit from your passive income portfolio and make a living off of it when you pass away. BOOM, Generational wealth! What is a dividend? or What is a stock dividend? 

 

Dividend Definition:

          Dividends are cash payments that a company makes to shareholders. They are passing their profit on to you in the form of dividend payments.

How to get paid dividends from stocks?

          Getting paid dividends from a dividend paying stock is simple. You need to be the owner of the stock prior to the ex-dividend date. As long as you own the stock by that date you will receive the dividend. Companies announce their dividends and when they do they also provide an ex-dividend date.

How often are dividends paid? How often do companies pay dividends?

          Dividends can be paid twice a year, quarterly, or even monthly. Companies pay out dividends ranging from $0.10 to $6 per share or more. You aim to collect these dividends as a dividend growth investor in order to build a passive income stream for retirement use. If you're just getting started, check out this guide on choosing the right stock broker.

Do all stocks pay dividends to investors?

           No, check out below on how to determine if your chosen stock pays a dividend.

How to tell if a stock pays dividends?

          Determining if a stock or company you are interested in pays dividends takes some research. The first place I check is Dividend.com to see if they have information on their dividend. For example, here is their page on Apple's Dividend. This is a good first stop to see information like dividend yield, number of years that a company has been paying a dividend, or to see historical dividend payments. You can also look at a companies investor relations page on their website to see if they have information about dividends as well. Here is Apple's investor relations page that show their dividend history.

Why should you buy dividends stocks? Are dividend stocks worth it?

          Historically, dividends have had a significant impact on the total return that stock market investors receive. According to the Hartford Funds example study of the importance of dividends and compound interest, they accounted for 84% of the SP500 return in the last 40 years. Dividends are important because they represent a portion of the company's earnings that are paid to shareholders. Dividend growth investors love dividends because they provide them with a steady stream of income, which can help them cover their expenses in retirement. Is it better to reinvest dividends? Dividends also have another added benefit: compounding. When you reinvest your dividends into more shares of the same stock or another dividend-paying stock, you're buying at a Dollar Cost Averaging (DCA) and getting even bigger payouts down the line. Dollar cost averaging is when you sometimes buy low and sometimes buy high, thus giving you an average stock price. Check out this post that shows why DCA is king! This can result in significantly larger portfolio values than if you had just left your dividends alone. Reinvesting dividends is one of the key tenets of dividend growth investing, and it's what allows investors to build ever-growing streams of income.

image showing the power of dividends and compounding

Source: Hartford Funds

          Dividend growth has outperformed the SP500, with a track record of slightly greater returns and lower volatility over time. Dividend growers and creators have generated an annualized return of 13.20% with a standard deviation of 12.57% when compared to the SP500 index's 12.57% return.

Average annual returns and volatility by dividend policy

Source: Hartford Funds

          Comparing dividend growers/initiators to the SP500, this difference doesn't appear to be significant; yet it translates into a difference of $7,582 in capital appreciation per $100 between 1973-2020.

returns of SP500 index stocks by dividend policy

Source: Hartford Funds

          It's safe to say that dividends are an important to the power of the stock to generate strong returns over time. But, what are the advantages and disadvantages of dividend investing? In the next section we'll take a look at that. 

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Dividend Investing Advantages and Dividend Investing Disadvantages

Income Investing Disadvantages:

  • Dividends are not always guaranteed. In 2020, there were dozens of companies that cut their dividends due to financial pressure. At any moment, companies can decrease their dividend payout or completely get rid of it. However, many of the companies on the Dividend lists maintained and even increased their dividends during this time. This highlights the importance of investing in quality companies.

  • Dividends are taxable if held in a taxable brokerage account.

  • When compared to index investing it decreases diversification since you're really only invested into “large cap” stocks. You'll be missing out on the mid-cap and small-cap stocks. This can be overcome by investing in various ETFs.

  • You have to pay attention to the companies you are investing into to ensure they remain healthy and can continue to grow and increase their dividend.

Income Investing Advantages:

  • Reinvesting dividends during sideways moving markets, bear markets, and corrections, purchases more shares with the dividends while the prices are lower.

  • Historically dividends have provided 41% of the S&P 500 total return across the last eight decades.

  • Creating passive income without having to sell you underlying capital. That capital will continue to grow as companies raise their dividend. Your passive income could grow even if the underlying asset has decreased in value due to a price drop or bear market. You don't need to worry about selling shares in retirement if the stock market falls as long as the dividend remains intact.

  • The psychological effect of dividends when there is a market downturn. Continuing to see your dividends growing and posting to your account boosts confidence during market volatility. During 2022 the market fell around 18% across the board while my dividends increased by 12% during the same time. Seeing those payments kept my motivated.

Dividend Growth Investing Goals

  • Build an income focused portfolio that revolves around dividend paying stocks. Hold those shares for years as they increase in value and increase their dividend.

  • Seek out a balance between growth and income. Desired yield will depend on age as older investors focus on shifting to higher yielding assets with less growth. Ideally, if investing early enough, an investor's yield on cost rises to meet income goals in retirement.

  • Use incoming dividends and DRIP to purchase more shares and then hold those shares into retirement.

Dividend Investing Terms

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1. Cash Dividends

Dividends that are paid out in cash directly to the owners brokerage account. Cash dividends are the most common.

2. Declaration Date

Date that dividend is announced.

3. Dividend Aristocrats

Companies that have been growing their dividends for 25+ years. Here is a list of dividend aristocrats. 

4. Dividend Challengers

Companies that have been growing their dividends for 5+ years. Here is a list of dividend challengers.

5. Dividend Contenders

Companies that have been growing their dividends for 10-24 years. Here is a list of dividend contenders.

6. Dividend Kings

Companies that have been growing their dividends for 50+ years. Here is a list of dividend kings.

7. Dividend Yield

The percentage of the share price that is paid as a dividend is calculated using dividend yield. The formula to calculate how much your investment will be pay is:

Download my FREE Dividend Formula Calculator here!

How to calculate for dividend yield:

 

Investment Amount X Dividend Yield = Annual Dividends (Passive Income)

 

For example if you invest $10,000 into Johnson and Johnson ($JNJ), which yields around 2.39% as of this writing, you would get paid $239 a year. This would equate to $19.91 per month. This would continue to grow if JNJ continued to raise their dividend, which they've done for 59 years straight! Here's the formula using our example:

 

$10,000 X .0239 = $239

 

You can use a variation of the same formula to calculate how much you would need to invest to earn a particular amount in passive income. For example, if you wanted to earn $24,000 in passive income a year, how much would you need to invest?

How to calculate investment for dividends:

 

Annual Dividends (Passive Income) / Dividend Yield = Investment Amount Required

 

Using the JNJ example above and our example that we wanted to earn $24,000 we would need to invest $1,004,184. Here's the formula using our example:

 

$24,000 / .0239 = $1,004,184

how much to invest to earn $1000 a month in dividends

Dividend yield is calculated using the current stock price and the current annual dividend. JNJ's stock currently sells for $179.44. It also pays a quarterly dividend of $1.06 or $4.24 per year. The formulas for the example are below:

 

Annual Dividend / Current Stock Price = Dividend Yield

 

$4.24 / $179.44 = .0236 (or 2.36%)

 

Companies sometimes continue to raise their dividend after you purchase shares. For example, the Dividend Aristocrats is a list of companies that have been paying and raising dividends for at least 25 years. How this factors in for you is what is known as yield on cost.

8. DRIP (Dividend Reinvestment Plan) or Reinvesting Dividends

These are programs offered by most brokerages to reinvest you dividends automatically to buy more share or fractional shares of the company that paid the dividend. These were widely popular when brokerages had commissions on stock purchases and their DRIPs didn't charge a commission when reinvesting. Most brokerages today have commission free trading so enabling DRIP is a personal investor choice. You can easily purchase shares of your choice with your dividends if you choose not to use DRIP.

9. Ex-Dividend Date

The first day that new buyers are not eligible to receive a dividend. Investors must own the stock by that date to receive the dividend. Investors who purchase the stock after the ex-dividend date will not be eligible to receive the dividend. Investors who sell the stock after the ex-dividend date are still entitled to receive the dividend, because they owned the shares as of the ex-dividend date.

10. Ordinary Dividends

Dividends that are taxed as ordinary income at the federal tax level. To learn more about the types of dividends and taxes check out this post.

11. Payment Date

Date a dividend is deposited into your brokerage account.

12. Qualified Dividends

These dividends are treated as long range capital gains and therefore taxed at a much lower rate than ordinary dividends. A majority of dividends fall into this category. To learn more about the types of dividends and taxes check out this post.

13. Record Date

The official owner on this date gets the dividend. It takes three business days from purchase to be the owner of record. Thus, you would not collect the dividend if you purchased two days before the owner of record date. In other words, the ex-dividend date (date not eligible to collect dividend) is two business days before the "owner of record" date.

14. Special Dividends

These are dividends that are not paid on a routine basis and are normally higher than the average dividend. Special dividend can be paid at any time if the company has extra cash they wish to return to shareholders. The nature of these dividends is unpredictable and shouldn't be relied on as part of your passive income.

 

15. Yield On Cost

Yield on cost is the dividend yield based on the current cost of your shares in your portfolio. You can calculate yield on cost using the above formula but you use your cost (cost basis) in place of the current stock price. Yield on cost can increase your passive income considerably over 10-40 years of investing.

 

Annual Dividend / Cost Per Share (Cost Basis) = Yield on Cost

Warren Buffet invested in Coca-Cola in 1988 and his company owns around 400 millions shares which is $1.299 billion. His yield on cost in 2021 is 52%!

How to use Dividend Reinvestment Plans (DRIP)

          Dividend reinvestment plans assist you in automatically reinvesting your dividends. When you have a DRIP plan set up, the businesses you own pay you dividends and your broker buys more shares with the cash. Many novices wonder if they should use a DRIP.

 

          These plans were used primarily because there were previously high costs for purchasing stocks. DRIP was created to allow investors to purchase stock without paying extra fees. Most brokerage firms now provide free trading, so that advantage is no longer available. If you're uncomfortable with the idea of forgetting to reinvest your dividends, Dividend Reinvestment Automation might be a good fit. This is possible DRIP automation. You should continue to reinvest your dividends until you need to rely on that income or you want to reinvest those dividends manually into another company.

 

          As previously stated, dividends are a substantial component of overall market returns so reinvesting them via DRIP or manually is super important. Ultimately, DRIP is a personal decision for everyone. When I was on duty in the military, I used drip because internet connectivity was unreliable. I also DRIP'ed until I made around $200 per month from my dividends. That's when I decided to leave DRIP on for some firms and turn it off for others. For example, I kept DRIP on for Apple and my ETFs because I knew I want to keep dividends flowing into those positions. Again, how and when you utilize DRIP is entirely up to you.

When should I sell a stock or shares of a position?

          Each company I invest in I plan to hold for as long a possible. I analyze the company and their performance metrics prior to investing. Each company added to my portfolio serves a purpose. Normally, if I can explain why I want to add a company to my Wife so that she understands it I know I've done enough research. The reasons I sell shares are:

 

  1. The investment no longer matches the reason I added it to my portfolio

  2. The dividend is cut or eliminated

  3. The investment consistently underperforms

  4. The metrics I use to evaluate the company indicates the dividend is at risk

  5. The position has gotten to large or I want to rebalance

 

The investment no longer matches the reason I added it to my portfolio

          Every stock I invest in has a purpose inside my portfolio. Be that dividend yield, growth, income, or sector assignment. For example, at one time I owned Johnson N Johnson ($JNJ), Merck ($MRK), and AbbVie ($ABBV). I sold my JNJ and MRK shares to consolidate into ABBV. I also plan to sell my growth stocks as I approach retirement to invest in more income producing assets.

 

The dividend is cut or eliminated

          The primary purpose of my portfolio is to build a passive income stream that I can use to retire early. A position that cuts their dividend or eliminates it could reduce my passive income by 2%-10% or possibly more. It's important to remember that these aren't hard and fast rules. Disney ($DIS) eliminated their dividend during the Corona Virus pandemic. In my eyes this was a smart move since Disney parks and Cruise lines were closed. I chose to keep Disney stock in my portfolio and it still makes up 3% of my portfolio to this day. Had I sold Disney I would have missed out on a sizeable amount of growth in their share price over time or the passive income when they reinstate their dividend.

 

The investment consistently underperforms

          An asset that underperforms the overall market could drag down your portfolio's performance. Under performance of 1% over 30-40 years could substantially impact the end dollar amount that shows up inside your brokerage account. It's important to remember that assets could underperform one year then perform extremely well later. Keeping a company is a risk either way. In the past, I chose to invest in Nike ($NKE). I held them for about nine months before I chose to sell. The investment had only grown 2%. What happened after I sold? Nike sprung up 12% the month after I sold. I got impatient and emotional which clouded my judgment. Nike was a solid investment but I was more worried about performance. Choosing to sell for this recent should be carefully considered.

The metrics I use to evaluate the company indicate the dividend is at risk

          I routinely check my investments to ensure that they are healthy and can continue to pay their dividends. Understanding dividend payout ratio, free cash flow, profit margin, and more is important. For example, I personally try to ensure my assets keep their dividend payout ratio below 70. Once, I see the metrics indicating that the dividend growth could slow significantly or become unsafe I tend to exit those positions. You can check out this post to understand how I evaluate dividend stocks.

The position has gotten to large or I want to rebalance

          This is the metric I use the least and that's a personal choice. If one of my assets starts to dominate my portfolio I consider selling the profits to rebalance. Normally, I keep an eye out for assets that are 2%-4% above my target allocation. The danger with selling an asset that is performing well is that you could be selling some of your best performers. Additionally, when you sell you need to consider the tax implications.

How to rebalance your portfolio?

          Holding a mixed allocation of assets or diversification is key to long term investment success. Sure, you could get luck picking the right company but 1000's fail to do just that each year. Why is that important? Some companies or sectors will grow faster, some will grow slower, and some might fall one year. If you want to understand portfolio allocation and stock sectors. Check out this post. It's normal for your portfolio to become unbalanced over time. Each stock or ETF in your portfolio should have a goal percentage assigned by you. Rebalancing frequency is up to you as the investor. Below is my portfolio as of December 2022 showing current allocation and goals.

purachse plannner for dividend portfolio

There are two main ways you can rebalance a portfolio, either by using a Sell/Buy or a Targeted Investment strategy

 

Sell/Buy

          The first method involves selling shares from the positions  that have appreciated in value. This is my least favorite choice since it results in taxable events inside your portfolio that I have to account for. It also sells assets, which are usually the some of the most successful. If you pick this path, you'd take the profits from one firm and invest them into a position requiring funding to reach your goal percentage. You may rebalance or redistribute your portfolio this way every four weeks, semi-annually, or annually. It's ultimately up to you. To lower your taxable obligation, sell any stock that has been held longer than a year. Remember, that any shares sold that were kept for over a year would be classified as long-term capital gains, which are taxed at a significantly lower rate. You can do this by setting your account to FIFO or First In, First Out when selling on your brokerage account.

Targeted Investment

          The second strategy I utilize is the one I recommend. I deposit funds each month to purchase new shares to my portfolio. Every month, I contribute around $3000 to my portfolio. Instead of selling shares, I purchase assets below my goal allocation with the extra cash. For example, if AAPL's percentage in my portfolio was at 2.47%, I'd buy another share or two to bring it up to 3%. This technique does not result in taxable events within your investment portfolio nor does it involve selling assets.

 

          It's important to remember that you don't have to be married to your goal allocation. You could invest more or less in any company or ETF you own at anytime. In early 2020, I bought a significant stake in Apple which caused it to become 14% of my overall portfolio. I saw an opportunity to purchase Apple prior to their stock split and I wanted to take advantage of that opportunity. I knew my AAPL position would be way higher than my goal for months. I offset this by not purchasing Apple shares for another ten months so it slowly returned to around 4% naturally as I funded my account. You can also use a combination of Buy/Sell and Targeted Investment if that method suits your needs at the time.

How to make a dividend portfolio?

          In this section we will take a look at a few example portfolios and compare them to the SP500. Well look at a few dividend ETFs because I always get asked "What's the best dividend ETF?" The foundation of these portfolios is centered in Exchange Traded Funds (ETFs) with low expense rations and strong track records. Of course, past performance doesn't equal future performance. The portfolio balances diversity, growth, and dividends. This allows beginners to start investing and get their money working for them as they continue to learn the stock market. Once, you understand how to pick stocks you can branch out or stick to these portfolios.

Check out my personal portfolio updates to understand how a Dividend Portfolio might grow under real world conditions.

The three portfolios consist of the following:

Portfolio #1 - 100% SCHD (A favorite ETF among dividend investors)

Portfolio #2 - 50% SCHD / 50% NOBL (NOBL is another strong dividend ETF centered around dividend aristocrats)

Portfolio #3 - 100% VOO (Used as a performance benchmark)

View the interactive portfolio used in this section, check out Portfolio Visualizer's Backtester Here

Portfolio example.jpg
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          You can see from the backtesting that the performance of each portfolio is closely related. During this time period Portfolio #1 and #2 both beat the benchmark. This may not always be the case. What important to review as dividend investor, who wants to ultimately live off dividends, is the income that portfolio generates. You can see that portfolio #1 generates significantly more income than #3. This comes down to the dividend yield of each portfolio. Balancing a dividend yield around 3-4% is a good starting point for new investors.

If you want to learn more about the ETF SCHD, check it out here!

If you want to learn more about the ETF NOBL, check it out here!

If you want to back test your own portfolio, use Portfolio Visualizer here!

Get a FREE copy of my Dividend Investing Quick Start Guide!

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If you haven't done so, join my mailing list to stay up to date!

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