Building Income by Investing in Dividends Stocks

Often, when we think about making money through investing, we think about picking the right stock, and then watching as it goes big, resulting in fantastic capital appreciation. Or, perhaps we think about choosing a solid index fund to provide solid returns over time, building up a nest egg for which the 4% withdrawal rule fulfills every need.

What sometimes gets overlooked is a way to build up regular investment income now — with the help of dividend stocks.

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Investing in Dividend Stocks

What are Dividend Stocks?

There are companies that offer regular payouts to shareholders. You are rewarded for holding on to the stock by receiving a cash payment every month, quarter, six months, or year. It’s general a small payment, like $0.15 for each share that you own. So, if you own 100 shares of a company that pays a $0.15 dividend each quarter, you would end up with $15 every three months — or $60 a year.

Of course, the point of using dividend stocks to build an income stream is to add to what you hold so that you get a bigger payout. It’s also possible to buy different dividend stocks, adding to your portfolio, and mixing different companies with various dividend yields.

Most of the time, it’s possible to purchase partial shares, so you don’t have to limit yourself to only “cheap” dividend stocks. Companies pay dividends in the hopes that investors will buy shares, and hold on to them. Companies can raise or cut dividends at will, but they have to announce dividends in a timely manner. This provides you with time to invest in a dividend stock if you want the payout.

DRIPs

A number of dividend paying companies also offer dividend reinvestment plans (DRIPs). When you participate in these plans, your payout is automatically used to buy new shares of the company. Most DRIPs won’t charge you a new transaction fee for participating, and many brokerages will allow for the reinvestment of dividends without charging a new fee.

Using DRIPs can help you build your dividend income portfolio a little faster. Take our example above. If you are receiving $15 each quarter as a result of your dividend payout, and the company’s stock is priced at $30 a share, you get half a share each quarter. By the end of the year, you have two new shares. The first payout of the new year sees you with 102 shares, rather than just 100 shares. So you receive $15.30, instead of $15.

As you can see, though, over time DRIPs help you build up the number of shares that you have. With a higher number of shares, you receive a bigger payout, which in turn automatically gets you more shares with the dividend reinvestment. The cycle repeats itself.

Dividend Aristocrats

There are many different ways to screen for potential dividend investments. One option, though, is to consider dividend aristocrats. These are companies that have increased dividends each year for 25 consecutive years.

Even during times of economic upheaval and recession, these companies have seen at least one dividend increase — even if it is only by a single cent — each year. Dividend aristocrats are of interest because they are likely to keep increasing dividends. Some of the companies on the list have increased the payout every single year for more than 40 years.

Of course, a company can cut its dividend at any time. Just because a company is a dividend aristocrat this year doesn’t mean that it will increase dividends next year; it’s even possible that the dividend will be cut next year. However, there is a pretty good chance that a dividend aristocrat will keep increasing dividends, and that can be good news for your portfolio — especially if you use DRIPs.

Building an Income Stream

Understand that most investors aren’t going to see a significant income stream from dividend stocks immediately. Indeed, unless you have a large amount of capital at your disposal, it will be slow going. You’ll likely only see a couple dollars a quarter at first.

The idea, though, is to build up your portfolio. Carefully choosing solid dividend stocks can help you increase your holdings over time, and gradually build up your revenue stream. You can improve your portfolio during the building stage with the help of DRIPs. Add to your portfolio by making regular purchases of stocks as well. Dollar cost averaging can be your friend as you build a dividend portfolio.

It can take up to 10 years — or more — to create a successful dividend portfolio that begins to provide significant income. And, throughout, you have to be aware of the risks, including the risk that your chosen stocks could tank. But with careful planning and persistence, it is usually possible to improve your situation and create a stream of income from your investments that provides you with something substantial on a regular basis.

Photo from Wikimedia Commons.



Author

By , on Aug 6, 2012
Miranda Marquit Miranda is a professional personal finance journalist. She is a contributor for several personal finance web sites. Her work has been mentioned in and linked to from, USA Today, The Huffington Post, The San Francisco Chronicle, The New York Times, The Wall Street Journal, and other publications. She also has her own personal finance blog: Planting Money Seeds.

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{3 Comments}

  1. Will:

    Nice article. I never really hear about whether starting a dividend portfolio is good for a young/starting investor. Should I focus on growth through an index or diversify into dividend stocks as well? Any thoughts?

    Thanks

  2. I agree with the idea of building income stream. Investing in dividend stocks can be helpful for you to increase your holding over time and will build up your revenue stream. It takes time but you can improve your portfolio with the help of DRIPs.

  3. What do you think of buying dividend stock and then selling covered calls on the stock to bring in extra income. You could make money if the stock goes up and make money on the dividend and make money on the covered call. The covered call will caps your upside potential but it can create a cash-flow. And if you get exercised and have to sell the stock back you just buy back the stock and still take advantage of the dividend.

    What do you think?

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