Strategy helps with money also.
I know, it’s a terrible pun, but I had to make it. We cover lots of different income options on the Wealth Artisan. Income is a big subject for obvious reasons. One method for income generation is passive income. In short, passive income is money that is generated with little or no effort on your part.
One of the most common sources for passive income is a dividend paying stock. There are many ways, methods, books, and philosophies on dividend investment, but with all of that information, people seem to be terrified of investing in dividend paying stocks. Dividend investment is attractive for multiple reasons:
- It is passive income.
- It is generally taxed at a lower rate.
- It is fairly dependable and can be safe.
- It isn’t difficult to find a decent yield.
While banks are only paying about .10% on your savings accounts and .5% on your CDs, you can find dividend paying stocks all day long yielding 3-4%. Yes, that isn’t the most stellar return, but it’s far better than the half percent your bank is willing to pay.
Market Volatility Scares Me
If you’re afraid to risk your principal in the stock market, then your immediate reaction is intelligent. You should never jump into something that you don’t understand. But that doesn’t mean that you should stay away forever, it means that you need to learn more about the market. And, unless you’re close to retirement, you shouldn’t be so terribly risk averse.
Don’t be lulled into a false sense of security, because your money is in a CD. If your CD is yielding .5%, then you’re losing money. At a normal rate of 3% inflation, you’re losing 2.5% in principal each year. The deceitful part of this is the number in your account never changes, in fact it goes up slightly, how could you be losing money?
There is nothing safe about leaving your money in a low yielding CD, it just guarantees a more predictable erosion (assuming inflation doesn’t go haywire) of your principal.
What Makes Dividend Stocks So Great?
Besides the reasons listed above, dividend investing is generally easy to do. It doesn’t require a constant concentration on the daily fluctuations and nuances of each bad news day. You pick a company you like, a company with a good track record, a company with solid financials, and you buy them at a decent price:
Slight Deviation: I must emphasize the “decent price” point. Don’t just buy a stock, ensure the price is decent. You can use P/E ratios, PEG Ratios, and peer comparison to help determine if the price is a good one. Just because a company is good, that doesn’t mean it can’t be overvalued. I wouldn’t touch Amazon (AMZN), or Verizon (VZ) right now. Pick your stock’s price, and wait.
Back to what I was saying: you don’t have to worry about the DOW spiking down, you buy a good company, and you hold it. If you chose well, then you should enjoy steady dividends and a gradual appreciation of stock price. There will be rough patches of course, but those will be ironed out in time. I like to reinvest the dividends as this has the same effect as compounding interest in a bank account.
How Do I Know I Will Get Dividends?
In short, you won’t. It’s up to the company to approve dividends, but that is why you pick companies with a good track record. This has been made easy by indexes like the Dividend Aristocrats Index and the Dividend Achievers index. These indices are composed of companies who have consistently declared and increased their dividends for the past 25 and 10 years respectively.
If you pick a company from these lists, then you’re probably pretty well guaranteed a dividend. Don’t let that be your only criteria though. You should try to predict which companies will fall out of the indices. This can be done by comparing the % increase of dividend against the % increase in EPS (Earnings Per Share). If the company increase dividends by 5%, but EPS only increased by 2%, then they are cannibalizing their earnings to pay the dividend, and that is unsustainable.
You will also want to look at DPR (dividend payout ratio), this is the % of EPS that they are paying out in the form of dividends. I have a 60% rule, meaning that no more than 60% of the EPS is allowed to be used for dividends. Find out the DPR of your favorite stocks using the Dividend Payout Ratio Calculator!
Now, Dividend and Conquer!
Sorry, I had to one last time. Dividend paying stocks can be an excellent method for growing your savings and income, but they are useless if you’re afraid of them. Learn as much as you can, get out there, and conquer your finances by divvying up your portfolio with dividend paying stocks. CHARGE!
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Great article! I’m not a huge fan of investing in stocks but I’m considering putting some money into a fund of divident of paying stocks. I think this is the more practical way for the average investor who doesn’t have the time or knowledge (like myself) to follow the market.
-Ravi Gupta
Hello Ravi,
Some people are just too busy to follow the market, and that’s OK. You can speak with a financial advisor and discuss some dividend funds that would fit your needs. The good thing about funds is it is an easy way to diversify!
Thanks,
Timothy
I love the dividend aristocrat list as well. I actually use that as my first stock screener when I created my perpetual income machine (i.e. the dividend portfolio lol)
Hey Evan,
Thanks for stopping in! I love the Dividend Aristocrats Index as well. If I can’t find anything I like on that, I’ll look over the Dividend Achievers Index. Those constituents only have a 10-year history of consistent dividends, but you can still locate some good finds. Good luck with your perpetual income machine!
Thanks,
Timothy
Love the title! Dividends are a great way to invest, especially for those that are worried about the market. It’s a relatively safe, low risk investment, that should outpace inflation…or keep up with it at the very least. It amazes me how many personal finance bloggers, and even planners, miss the big picture of inflation eating into savings accounts.
Hey Justin,
It surprises me as well being that inflation is being so understated. I think that having a whole number in a bank account that never goes down, people get a false sense of safety. I’m glad you like the title and will continue spreading the word about inflation’s effect on savings.
Thanks for stopping by!
Timothy
Divided investing is one way to deal with a fluctuating market. As I get closer to retirement, I expect to increase dividend investments.
Hey Krant,
Dividend investing can really smooth out the peaks and valleys in everyday market volatility. Today, many investors advocate silly, short-sighted investments and day trades leveraged to the eyeballs. This market wizardry doesn’t create real wealth over the long term. I would advocate dividend investing from the beginning. The compounded effect of dividend reinvestment would obliterate any of these short-term returns that people try to realize by buying high, and trying to sell a few cents higher. It just takes time and patience to realize your gains.
The funny thing is, because everyone is trying to day trade, the patient dividend investors will be able to reap the reward because we’ll always have suckers buying and selling even at the highest peaks. Enjoy your dividends and your retirement.
Thanks for stopping in!
Thanks,
Timothy
Dividends have been an important component of total market return throughout history so ignore them at your peril. You have given some good indicators to use for picking good dividend stocks. Using these plus some diversification and averaging into a position should offer some decent protection against a Citigroup or GM that has to cut a dividend.
Hello OptionsDude,
You hit the nail on the head. For anyone who is afraid of stock picking, I would suggest dividend investing via funds or indices. Much of the total return, as you have noted, is because of dividends. People, for some reason, want these magical trading instruments, because dividends are “boring.” I’ll take the dividends any day. Great to see you around here!
Thanks,
Timothy
I’ve always had money in savings accounts but the low amount I’m getting right now (1%) is making me want to invest in something slightly more risky.
Hi Edwin,
Yep, the savers are getting punished terribly because of the fed’s cheap money policies. It’s forcing a lot of retirees to choose between eating into their principal or take more risk in the market. I’d like to say this weren’t one of their goals, but I think I’d be lying.
Thanks,
Timothy
Nice! As you point out, there are no guarantees when it comes to dividends, but stick to stable companies you cut your risks considerably.
Hey MoneyCone,
Indeed! There’s no predicting the future. The closest you can get is looking at past consistency. No company wants to break a 25 year history of dividend payments unless they are facing something truly dire.
Thanks,
Timothy
Great write-up! Seems like dividend articles was popular today
I have to wonder if you are going the DRIP route, or gather money and then when you think the market is low, buy in…
Hello MoneyReasons,
yes they were! I don’t really commit to one method. I like dripping as it averages us down, but if a price is low, I buy in. I wish I could set it and forget it, but I’m too active.
I look forward to the day when my DRP has a large effect than my principal contribution! 
Thanks,
Timothy