A dividend is money a company pays it's shareholders back - think of it as profit sharing; you own some of the company, so if the company is profitable you actually get to see some of that profit back as a shareholder. Not every company pays a dividend, but many do - and many of them do this on a regularly, quarterly basis (meaning every 3 months). The amount of dividend a company pays can vary, and is usually listed as "x per share", meaning that for every share you own, they will give you "x" per year.
What's really nice about a dividend (in addition to being free money) is that most places that let you buy stock (brokerages, like eTrade or Charles Schwab) let you reinvest your dividends. That means that instead of getting, say, $10 every 3 months for your investment in AT&T, the brokerage will give you $10 more worth of AT&T shares.
Let's actually use AT&T as an example. At this writing, AT&T costs $36 a share, and since they pay $1.88 per share per year (or $0.48 per share per quarter), that means that if you buy AT&T stock at today's price, you'll end up getting paid back about 5.3% every year. Let's compare that to what you would get if you put, say, $1000 in a savings account at a bank.
I used Bankrate to find the best average savings account rates - you can check with your bank to see if you are getting anywhere near the listed 0.52% - I'm betting you aren't - and it's not your fault, it's just that most banks pay a ridiculously low amount of interest to you.
| Dividend Reinvestment vs. Bank Savings Account | ||
| AT&T at 5.3% | Bank Savings at 0.52% | |
| Investment | $1,000.00 | $1,000.00 |
| Year 1 | $1,053.00 | $1,005.20 |
| Year 2 | $1,108.81 | $1,010.43 |
| Year 3 | $1,167.58 | $1,015.68 |
| Year 4 | $1,229.46 | $1,020.96 |
| Year 5 | $1,294.62 | $1,026.27 |
| Year 6 | $1,363.23 | $1,031.61 |
| Year 7 | $1,435.48 | $1,036.97 |
| Year 8 | $1,511.57 | $1,042.37 |
| Year 9 | $1,591.68 | $1,047.79 |
| Year 10 | $1,676.04 | $1,053.23 |
| Year 11 | $1,764.87 | $1,058.71 |
| Year 12 | $1,858.41 | $1,064.22 |
| Year 13 | $1,956.90 | $1,069.75 |
| Year 14 | $2,060.62 | $1,075.31 |
Notice what happens at year 14 - the stock market investment has doubled your money, compared to the bank, which has given you a puny $75 instead.
Now of course, the first thing most people say is, "but stock prices go up and down, how will that affect my yield?". The answer is, surprisingly, that this sort of thing is actually GOOD for you. You see, the stock will pay you the dividend regardless of the stock price fluctuation. In other words, you don't get 5%, you get the $0.48 per share! So let's imagine that the market has a downturn, and AT&T stock goes down to $20 a share. Your original investment of $1000 at $36 a share means you bought about 27 shares. So, you get $0.48 per share, or $12.96, every quarter. So, if the price stays at $36, you get roughly an addition 0.36 shares every quarter, or about 1.4 shares per year - compounding, of course, but let's just think about the easy first year scenario.
Now, if the stock price goes down to $20, you still get $12.96 a share every quarter, but at $20 a share your dividend reinvestment nets you 0.6 shares a quarter, or 2.4 shares that first year.
"Oh", some folks say, "but my total investment is worth less". Yes, that's absolutely true. You now, after the first year, may have 29.4 shares that are each worth $20 a share, for a total value of $588. Far less than the $1000 you put in.
But we dividend investors don't care. Why? Because - and here's the trick - we don't panic. Here's a secret for you, folks, and it's not a secret, you can Google and find all the information to back it up - the stock market is cyclical and fluctuates ALL THE TIME. It goes up. It goes down. It goes back up. Rinse, repeat. The trick is, don't panic - if the price goes down, don't sell - just wait for the upswing.
Now, this isn't true for every stock - some stocks go down because, well, the company isn't doing so well. That's why when you do dividend investing, there are a few key rules to follow:
1. Never invest money that you might need short term
Because the market does fluctuate, you should never invest all of your savings. Keep enough in your savings account for emergencies, like that impending car repair. When you stick money in the stock market, some folks say never to invest what you can't afford to lose. I think that's really just designed to scare people away from the market, because if you are smart and follow my rules, you are very unlikely to lose all of your money - but you might not be able to sell your stocks at a profit if you can't afford to wait for the next market cycle.
2. Never invest in a company that is paying a dividend "too good to be true"
There are companies that pay a big dividend specifically to attract investors - and while that might work out well for you sometimes, paying a 10% or even 15% dividend might be a sign of a fly-by-night or unstable company. I try to stick to big names that pay around 5%, and by big names I mean companies that you'll either recognize, or should because they've been around for a long time. Companies with a long history are less likely to go under! I'll list some specific recommendations at the end of this post, let's finish up the rules first:
3. Invest in a company that has a great history of paying out it's dividend
Companies that pay dividends don't have to pay dividends. And depending on how the company is doing, it may skip a dividend or two. For example, one of the companies I own some stock in is Kinder Morgan (KMI). They were paying a great dividend of about 8%, but their profitability went down, so they decided to lower the dividend rate (they are now paying closer to 3%). Other companies may skip paying a dividend for a quarter or two until they are more profitable. Honestly, when a company does this, it's a sign that management is smart, and eventually they tend to adjust the dividend back upwards - which is why I haven't sold my KMI. But when you are starting out, you'll feel saver and more comfortable by knowing that this whole dividend thing is for real and consistent.
4. Don't forget to turn on dividend reinvestment in your brokerage account
This is the easy part. There are plenty of brokerages to choose from (and if you are smart you'll go with one of the online ones like Etrade, Scott Trade, or Ameritrade - you'll pay almost nothing in fees compared to what you would pay if you did this through a "brick and mortar" brokerage, or your bank). Each brokerage will have a different way of setting up a "DRIP", or dividend reinvestment plan, but it's usually as simple as pushing a button. Just don't forget to do it!
Rules #1 and #4 are up to you to do, they are completely in your power. For that matter, finding the information required to pick a good stock based on Rules #2 and #3 is in your power too! To find a good dividend-yielding stock, I use Dividend.com and click on the "High Yield Stocks" link - and then page forward until I find the stocks in the 5% range. You can even go to the Dividend History section and look at a specific company's record - for example, if you do this for AT&T, you'll see that it has been both consistent about paying it's dividend every quarter for well over a decade - and not only that, it's been increasing the amount of dividend it pays!
Okay, earlier I did promise a few recommendations - here they are, listed in decreasing order of their percentage dividend yield based on today's prices:
Two of these seem to be in the "too good to be true" category - but do some research on your own and see if you can figure out why they are here in this list (hint - use the links provided above and look at their dividend history).
You may have noticed that the majority of the stocks above fall into two categories - telecomm and power. In a later article I'll talk about Utilities - companies that are considered utilities, like power companies, are some of the best dividend investments you can get, and often are perfect fits for the rules above - good and consistent dividend payment. Until then, do some digging on your own and see what you can find!
| Stock | Current Price | Dividend Yield | Market Sector |
| FTR | $4.55 | 9.20% | Telecommunications |
| CTL | $25.42 | 8.50% | Telecommunications |
| GSK | $41.29 | 5.30% | Pharmaceutical/Biotech |
| T | $36.06 | 5.30% | Telecommunications |
| VZ | $49.97 | 4.50% | Telecommunications |
| SO | $48.92 | 4.40% | Power |
| DUK | $75.30 | 4.40% | Power |
| GE | $29.10 | 3.20% | Manufacturing |
Two of these seem to be in the "too good to be true" category - but do some research on your own and see if you can figure out why they are here in this list (hint - use the links provided above and look at their dividend history).
You may have noticed that the majority of the stocks above fall into two categories - telecomm and power. In a later article I'll talk about Utilities - companies that are considered utilities, like power companies, are some of the best dividend investments you can get, and often are perfect fits for the rules above - good and consistent dividend payment. Until then, do some digging on your own and see what you can find!
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Disclaimer - I am not a financial expert and I am not responsible for any losses - or gains - you may make if you make decisions based on the information posted here. If you do make money, please feel free to let me know!
Disclosure - Wolfgang Rumpf owns shares in Kinder Morgan (KMI), Frontier Telecommunications (FTR), Centurylink (CTL), Glaxo Smith Kline (GSK), Verizon (VZ), Southern Company (SO), Duke Energy (DUK), General Electric (GE) and AT&T (T) mentioned above.
Disclosure - Wolfgang Rumpf owns shares in Kinder Morgan (KMI), Frontier Telecommunications (FTR), Centurylink (CTL), Glaxo Smith Kline (GSK), Verizon (VZ), Southern Company (SO), Duke Energy (DUK), General Electric (GE) and AT&T (T) mentioned above.
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