Dividend Investing Guide – How to Invest in Dividend Paying Stocks

Dividend investing is one of the more popular ways investors generate income to grow their investment portfolio. Many large, established companies issue dividend payments to shareholders. These dividends are issued as cash, which can be used to cover living expenses, or reinvested into more stock, thus compounding your investments. This Dividend Investing Guide examines dividend…
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Dividend investing is one of the more popular ways investors generate income to grow their investment portfolio. Many large, established companies issue dividend payments to shareholders. These dividends are issued as cash, which can be used to cover living expenses, or reinvested into more stock, thus compounding your investments.

This Dividend Investing Guide examines dividend investing in more detail, showing you how dividend investing can become a part of your investing strategy.

Table of Contents

Investing in Dividend Stocks

Once a company reaches its growth potential, the focus of the organization generally changes. Instead of using earnings to grow and expand the business, management may decide to start paying out dividends to shareholders.

This activity is very common in the natural business life-cycle, as a company can no longer maintain sizable growth. By no means is this a negative indicator of the organization, but is generally viewed as a good sign the company can sustain its earnings.

Let’s take a closer look at what are dividends and how they can benefit the investor.

What are Dividends?

A stock dividend is a distribution of a company’s earnings paid out to its shareholders. Announced by the company’s board of directors, dividends are used to distribute profits to the owners of the company – the shareholders.

When a company decides to declare a dividend, it is clear that management feels the company can no longer grow as fast as in the past. To retain shareholders as the company’s growth begins to slow, the profits are paid out as dividends.

There are several advantages to investors who invest in dividend-paying stocks. First, they can serve as an alternative source of income that can help supplement monies earned from a job. Secondly, a company that has a history of paying a dividend is generally viewed as a stable investment. While there are no guarantees, knowing a company has the cash to continue increasing dividends yearly is a good sign.

Types of Dividend Paying Stocks

There are several different flavors of dividend-paying stocks that are worth mentioning. Some companies are set up such that they pay almost all of their earnings out in dividends, while others focus on balancing dividends with the company’s growth. Each type has its advantages and disadvantages.

Here are a few types of dividend stocks that are popular amongst traders.

Blue Chip Stocks – Blue chip dividend stocks are generally considered the most stable of income stocks. Companies with a tradition of raising their dividend payout annually for 25 or more years would fall into this category. While the dividend yield may not be as high for many of these companies as a REIT or Income Trust, investors typically find more stability and less risk in investing in these types of securities.

Dividend Paying ETF – An ETF (Exchange Traded Fund) is a traded security that has the characteristics of an index mutual fund but trades like a stock. Many income investors seek out ETFs that specialize in dividend-paying stocks. Investing in a dividend-paying ETF can help diversify a portfolio while providing a source of income.

REITs – A Real Estate Investment Trust or REIT is a publicly traded company that purchases real estate assets such as offices, apartments, and even mortgage loans. Based on their tax classification, a REIT is required to pass the majority of their earnings on to shareholders in the form of dividends. Based on their high yield, REITs are often popular for dividend investors.

Mutual Funds – Many mutual funds also pay dividends. Each stock held within the mutual fund would issue dividends, which are then distributed to the fund and distributed to the shareholders. Some mutual funds focus their strategy on dividend-paying stocks, while in other mutual funds, it is simply a by-product of the stocks the fund holds in its portfolio.

Companies in Many Industries Pay Dividends – Paying dividends to shareholders is usually a sign of the company’s maturation and stability. This makes dividends less common with small companies, start-ups, and companies using the cash flow to fund more research, development, and growth.

That said, you can find dividend-paying stocks in various industries, including basic materials, consumer goods, financial, healthcare, industrial, services, technology, and utilities.

How Often Do Companies Pay Dividends?

Not only do dividend stocks differ in how they operate, but the frequency of the dividend payments also varies among companies. Here are a few of the most common dividend payout frequencies.

  • Monthly Dividend Paying Stocks – Many income trusts like CanRoys (Canadian Royalty Trust) pay their monthly dividends. Investors looking for a steady monthly income stream may want to explore assets in this category. CanRoys, REITs, and other trusts usually fall into this category, as they want to quickly pass their earnings to shareholders.
  • Quarterly Dividend Paying Stocks – The most common dividend payout frequency is quarterly. Many blue chip stocks distribute their dividend payments four times each year.
  • Onetime Payments – In some special circumstances, a company may announce a one-time special dividend payment. These payouts are not usually recurring and result from large cash balances a company is looking to distribute.

Important Dividend Investing Calculations

Those who invest in dividend-paying stocks should become familiar with several financial calculations and common ones like the price-to-earnings ratio. Here are some commonly used calculations and ratios that an income investor should understand.

Dividend Yield, or Current Yield

The current yield of a company represents the ratio of dividends paid out per year compared to the current share price. A stock’s yield fluctuates as the stock price changes and when a company raises or lowers its dividend payout.

While an important ratio when analyzing stocks that pay dividends, the current yield can be misleading for investments you already own. To calculate the true return on investment, an investor should understand the yield on cost.

Yield on Cost

Calculating the yield on cost for dividend stocks in your portfolio will help determine your return on investment. While the dividend yield is an important factor when analyzing a new income stock, it doesn’t help all that much for those you already own.

The dividend yield is calculated using the current share price of the stock. Instead of using the current share price, the average share price that was paid for the stock should be used to calculate the yield on cost. The results of this calculation will represent the shareholders’ true return on investment instead of what the stock is currently yielding.

Calculating the yield on cost is a critical step that should be performed periodically by dividend investors to evaluate the return of their portfolio.

Dividend Payout Ratio

The dividend payout ratio (DPR) is another important calculation that lets investors know if earnings can support the dividend. The DPR divides the dividends per share amount by the earnings per share. Growth companies that pay a small dividend will tend to have a lower dividend payout ratio compared to a well-established blue chip company.

As a general rule, most successful dividend investors avoid companies with a dividend payout ratio above 50% or 60%. Anything above that mark means the company may not be investing enough capital back into the organization. Even though a company’s growth has slowed, it is still critical to reinvest a portion of earnings back into the organization.

How to Use Dividend Yield to Inform Your Investment Strategy

Dividend Yield is one of the most widely used financial ratios to track income stocks. Dividend yield can help you establish your stocks’ actual worth and the risks and rewards associated with your investments.

This section will define dividend yield, show you how to calculate it, and explain how you can use it to inform your investment decisions.

What Is Dividend Yield?

Dividends, or the payments shareholders receive from the companies they invest in, can be assessed using the dividend yield.

The dividend yield, also referred to as the current yield, represents the annual dividends paid out by a company in relation to its share price.

Basically, it is the return on investment that an investor could expect to get if they invested in the stock at the current price and the company continued to pay out the same dividend.

The calculation assumes that the company will not make any dividend cuts and will either maintain the current payout or increase its distribution to shareholders.

While not a perfect representation of a company’s return on investment, the dividend yield is an important ratio that all income investors must understand.

Knowing how to calculate stock dividend yield can help you decide on the best investment route for your money.

How to Calculate Dividend Yield

Most income growth investors can easily pull the current yield of a company by looking up the stock information on financial websites or the company’s investor site.

Another option is to actually run the calculation by hand to compute the current dividend yield of a stock.

The following equation can be used to calculate a stock’s current yield –

Yield = Annual Dividends Per Share / Price Per Share

Now, let’s plug an example into the equation to see how it works.

If a stock has paid out $1.00 in dividends per share over the past 12 months and is currently trading at $25 per share, the current yield would equal .4 or 4%. This equation is represented below.

Current Yield = $1.00 / $25, or 4.0%

The Current Yield fluctuates as the stock price fluctuates. For example, if the stock price above increases to $30, the Current Yield would be 3.33% ($1/$30 = 3.33%). If the stock price were to decrease to $20, the Current Yield would be 5.0% ($1.$20 = 5.5%).

You can also easily run the calculation by increasing or decreasing the dividend payment, or both variables.

It is important to note that the current yield is constantly changing for a stock, as it relies on the share price (which is always moving up and down). An investor who purchased the stock at a higher price six months ago will have a much lower return (yield) on their investment (assuming the dividend remained constant) than someone who recently invested in the company. On the other hand, investors who bought at a lower share price (than the current price) would have a higher yield on their investment.

Dividend Yield Applies to Preferred and Common Stocks

The dividend yield can be used for both preferred stocks and common stocks. While there are several differences between preferred stocks and common stocks, one stands out in the discussion of dividend yield.

With preferred stock, a corporation provides a set dividend, giving you a clearer idea of how much you will yield.

Unlike the preferred stockholder, as a common stockholder, you receive voting privileges for the number of shares you own and the dividend can fluctuate.

Due to that difference, preferred stockholders can have a better idea of how much they will yield from the onset.

You can also use the equation to determine the trailing dividend yield and the forward dividend yield, which look at historical yield and projected future yield, respectively.

Since the common dividend is not a set value for common shares, you can look at the previous yields to gain insight.

Most Recent Full-Year Dividend/ Current Share Price= Current Yield

If you’re a common shareholder, here’s your best bet for tracking your potential dividend yield:

Share prices change and dividend increases and cuts occur frequently, but these measures can still serve as helpful analytical tools in your decision-making process.

Use Dividend Yield to Identify Stocks to Purchase

Using the dividend yield is most effective for investors identifying new investment options. It is a way to compare multiple income stocks against each other, regardless of their sector or industry.

For example, an income investor can compare the dividend yield between a banking stock and an energy stock, which will help guide the investment decision.

Which Industries Have the Highest Dividend Yield?

For the investor open to any industry, trends in dividend yields can help suggest which field to invest in.

Based on common sense (and historic yield data), industries with steady foreseeable profits tend to have higher dividend yields than less predictable ones.

In other words, as research implies, you can depend on people paying for staples even in times of need, so industries like telecommunications and utilities are safe moneymakers no matter the economic climate.

Entertainment, communication, and more basic needs like electricity and water yield high dividends and will continue to thrive, making those industries solid investment choices.

But, what about less predictable industries?

Using popular screening techniques like S&P, we can see the yields of corporations and industries.

The American Association of Individual Investors, commonly known as AAII, screens companies to measure yields as well. AAII suggests looking at the following characteristics:

  • Marked history of growing dividends
  • A successful current yield in comparison to the historic yield
  • Profits ahead of the field’s normal earnings
  • Below average liability

Using those characteristics can help you determine which corporations you might want to invest in. The AAII screens top-20 dividend yields ranged from about 3% to 7%, to provide some insight.

With a bit of research on a corporation’s website, you can find the company’s annual dividends.

Plug those into the dividend yield equation with the current share price, then see how the current yield stacks up against the criteria above.

Figures change, but if the dividend yield checks off the aforementioned boxes, you could be looking at a worthwhile investment.

Which High-Dividend Shares You Should Avoid

While determining what shares to avoid investing in may be a bit more challenging, there are a few tips to keep in mind.

Looking at the checklist above raises an important point for dividend investment:

A high dividend yield percentage does not automatically equal a lucrative investment.

It’s critical to look at how that yield has changed over time and how it competes with other corporations in the industry.

Sometimes dividend stocks soar, but long-term success is bound to more than a high yield percentage. When a stock’s dividend yield is unusually high, look at the reasons why.

With that information in mind, use the dividend yield formula and compare how the yield has changed over time.

As you can see, high-yielding dividends can be misleading.

Also, you may want to proceed with caution with one particular investment industry: Real Estate Investment Trusts.

As analysts suggest, REITs like Realty Income can house dangerous investments under the guise of impressive monthly payments and a recent upswing in dividend worth; however, they actually yield lower than competitors and can’t keep up with technologically advanced industries.

To recap, avoid falling into dividend yield traps by comparing dividend yields to past figures, growth rates, and competitors.

Determining Dividend Cuts

The current yield can also alert investors of a future dividend cut. As the share price of a stock decreases, the yield will initially rise (in some cases over 10%).

Since this ratio is calculated using past dividend performance, a drop in share price could be the first signal that a company is considering a cut. It can take several weeks for the yield to actually represent this type of event.

Alternatives to the Current Yield

The current yield of a stock is often used to estimate the return on investment based on the current share price. The calculation also assumes that the annual dividend payout over the past 12 months will remain constant.

While there are plenty of stocks that maintain or even raise their dividends, there will also be many companies that cut or eliminate dividends. A stocks share price will also continue to rise and fall, making the current yield a moving calculation.

One alternative that is commonly used in place of the current yield is the yield on cost (YOC). This calculation represents the return on investment based on what the investor actually paid to own the stock.

For example, consider blue chip growth stocks. Blue chip stocks are those which come from established companies with typical earnings in the billions who are considered financially stable for investment.

In the case of blue chip companies, the YOC can be much higher than the actual yield that a stock is currently returning.

Current Yield is Just One Factor to Consider When Investing

Understanding how the dividend yield is calculated and what it represents is beneficial for investors of dividend paying stocks.

The ratio represents the annual dividends paid out by the company in relation to its current share price.

As an independent investor, you can use this value to help make investment decisions and understand the return on investment that you could earn by purchasing a stock.

Consider calculating dividend yield in determining your next investment.

How to Calculate the Yield on Cost of a Dividend Stock

While the current dividend yield of a stock is readily accessible on any financial website, the yield on cost (YOC) is specific to your individual investments.

The dividend yield is calculated by taking the annual dividend of the stock and dividing it by the current share price. While this ratio can be an important metric, there are some flaws. First, it is a constantly changing number which makes it difficult to track. As the share price fluctuates, so does the current yield.

Another drawback of the dividend yield is that since it follows the current share price of the stock, it doesn’t really help an investor who already owns shares. This is where the YOC can come in useful for an investor, as it tracks the yield of the stock in relation to what you paid to own it.

Since the yield on cost represents each investor differently, it won’t be found on any financial website. Therefore, it is important for a dividend investor to understand how to calculate this financial ratio so it can be used to make critical investment decisions.

Yield on Cost Calculation

Calculating the yield on cost is a simple equation that takes two pieces of information. First, you need to know what the annual dividend currently is set at for the stock you are running the calculation on. If you don’t know what this is, check with your online broker or on one of the financial websites.

The second number that you will need is your average cost per share of the stock. You may need to do some figuring on your average share price, but your broker should be able to provide this data. Once you have collected both pieces of data, the following equation can be used to run the calculation.

Yield on Cost = (Annual Dividend / Average Cost per Share) * 100

As you can tell, the yield on cost equation is very simple and easy to calculate. It provides important information that is tied directly to the current yield that you are earning from owning the stock, not what the current yield states.

Example Yield on Cost Scenario

Let’s say that an investor purchased 20 shares of a dividend paying stock at $30 per share. A few weeks later, the investor decided to take advantage of a drop in the share price to dollar cost average down and purchased 20 additional shares at $26 per share.

The end result is that the investor now owns 40 shares of the stock at an average purchase price of $28.

If the company has an annual dividend of $1.00 per share, then the yield on cost for the investor would be equal to 3.57% based on the calculation below.

YOC = ($1.00 / $28.00 ) * 100

If the stock is currently trading at $30 per share, then the current yield would be equal to 3.33%, which is lower than the YOC. As the company raises or lowers dividends over time, the yield on cost for an investor will fluctuate and provide the investor with a true return on their investment.

Yield on Cost is Another Piece of the Puzzle

Similar to the current dividend yield, the yield on cost of a stock provides helpful information to an income investor. Unlike the current yield of a company, the YOC is different for every investor who already owns shares of the stock. This financial calculation can be very helpful as it gives the investor a true return on investment as opposed to the yield on the current share price of a stock.

What to Look For When Investing in Dividend Paying Stocks

Current Yield is one of the first things most investors look for in a dividend stock. You will commonly hear statements such as, “… stock XYZ is yielding over 6%” … or, “… stock ABC has a higher yield than its peers …”.

While there is no doubt the dividend yield can be a useful factor in selecting the top dividend paying stocks, it is certainly not the most important.

There is actually a lesser known (but just as important) financial ratio that investors can use to screen dividend stocks. This financial calculation is called the dividend growth rate and can provide beneficial data for the investor.

What is the Dividend Growth Rate?

The dividend growth rate of a stock is the annualized percentage increase in dividends for a certain period of time. For example, an investor may want to know what the 5-year dividend growth rate of a company is for his/her analysis. The time period for the calculation can be any desired interval (i.e. 5 years, 10 years, etc.).

On average, a company that has a solid history of strong dividend growth is more likely to continue raising dividends compared to a company with slow or negative dividend growth.

For example, a company that has consistently raised its dividend by 10% annually for the past 10 years is likely to continue that trend. Assuming the trend continues, investors would receive a 10% increase in income just by owning shares in the stock.

When was the last time your job could guarantee you a 10% raise every year?

Why Dividend Growth is More Important than Yield

The main drawback of relying solely on the yield of a stock is when the company decides to cut its dividend. Most calculations use the annual dividends per share paid out over the past 12 months divided by the current share price.

Since there is no guarantee the company will continue to pay the same amount of dividends, the results can become skewed. So in reality, the yield is using the past dividend performance and measuring it against the current value (or share price) of the stock, which can be misleading to an investor.

Factoring in the dividend growth rate, on the other hand, can actually highlight stocks that may have fallen off your radar. Many companies that have a double-digit growth rate generally have below average current yields making them unattractive to the common investor.

Let’s take a look at a company that has a current yield of 2.5% that has a growth rate of 10%.

Consider the return on investment you would receive in 10 years as the company increases its dividends by 10% annually.

  • Year 1 – 2.50%
  • Year 2 – 2.75%
  • Year 3 – 3.03%
  • Year 4 – 3.33%
  • Year 5 – 3.66%
  • Year 6 – 4.03%
  • Year 7 – 4.43%
  • Year 8 – 4.87%
  • Year 9 – 5.36%
  • Year 10 – 5.89%
  • Year 11 – 6.48%

As you can tell by the numbers above, in year 11 (10 years after the first increase), your original investment would be returning almost 6.5% in dividends. Compare those numbers with a stock that has a really high current yield and you won’t see the same returns.

The bottom line is that factoring in the dividend growth rate can identify top-notch dividend payers that give investors an annual raise that can’t be beaten.

Should investors only use the dividend growth rate to identify top dividend stocks?

No. Neither should you use the current yield to make all of your investing decisions. The reality is that both ratios are important factors in picking the top dividend stocks for your portfolio.

However, the dividend growth rate does provide useful historical information that provides more answers as to the direction the stock is heading.

Where to Buy Dividend Stocks

You can buy dividend paying stocks at a variety of brokerages, including online discount brokers, full-service brokerages, and sometimes directly from the company itself, through a Direct Stock Purchase Program, or DSPP.

You can often save more money by purchasing stocks directly from the company. However, you will have more paperwork to manage and may need to go through a third-party company to manage your shares.

If you prefer to consolidate your holdings and have all your stocks and tax records in one place, then you may prefer to buy your stocks through a brokerage firm. Here is our list of top discount brokerages.

3 Ways to Save Money on Investing in Dividend Stocks

Building a portfolio of dividend stocks is one of the best ways to build personal wealth, not to mention a steady income stream.

One of the biggest concerns to dividend investors, besides which stocks to pick, is the fees and commissions involved in building a stock portfolio. While online discount brokers have made it cheaper to invest, those $5 -$10 commissions for a trade can really add up – especially for the small investor.

A $10 commission on a $500 investment means an investor is paying 2% of their purchase in expenses. The whole point of dividend investing is to generate income and a 2% charge wipes out most of your dividend payment. There are a few ways that investors can help to save money investing in dividend stocks, which I have listed below.

1 – Direct Stock Purchase Plans (DSPP)

Investing through a direct stock purchase plan (DSPP) has plenty of advantages, most notably – no brokerage commissions or fees. Instead of buying and selling stock using a broker, these direct purchase plans allow investors to buy stock directly from the company in which they plan to invest in. There are a few one-time fees often associated with setting up these accounts, but they are minimal compared to commissions charged by a stockbroker.

Direct stock purchase plans are ideal for long term dividend investors looking to build a solid portfolio. They help to keep expenses low and allow investors the opportunity to reinvest any dividend payments received. Most plans also offer the chance to set up automated investments which will transfer money from a checking or savings account once per month and purchase stock. This is a great way to dollar cost average into a position over time as opposed to purchasing all shares once.

Each DSPP is different, with many being run by third party transfer agents. It is a good idea to investigate the specific details of each company’s direct stock purchase plan before investing. Direct stock purchase plans may not be for everyone, but they do offer the investor an alternative way to invest at a fraction of the cost of traditional brokerages.

2 – Dividend Reinvestment Plans (DRIP)

Another way to save money on dividend stocks is to setup a DRIP on each position. A dividend reinvestment plan, or DRIP can be setup to automatically purchase additional shares of stock from any dividends received with no commissions or fees. As mentioned earlier, investors who open up a direct stock purchase plan can opt to reinvest any dividend payments into purchasing additional stock shares. Since there are no commissions charged on these purchases, the investor can limit the amount of expenses needed to build a position in the stock.

Most discount brokers also offer the dividend reinvestment plan option to their clients. For example, I have selected to reinvest 100% of the dividend payments I receive for all stocks in my portfolio in my Fidelity brokerage account. Since no commissions are charged on these purchases, I can earn compounded interest on my investments at no cost. This allows me to not only save money on purchasing more stock shares but also helps automate more of my investing, which saves me time.

Direct reinvestment plans (and DSPP’s) also allow investors to purchase partial shares. Say you have $50 leftover, but the stock is trading at $100. A DRIP will automatically purchase .5 shares so that you don’t have to wait until you have enough funds to cover a full share.

3 – Dollar Cost Averaging

While it may sound more expensive, dollar cost averaging (DCA) can save you money on investing in dividend stocks. Dollar cost averaging requires the investor to make multiple purchases of stock instead of making a single purchase.

However, if the purchases are well planned, dollar cost averaging will ensure the investor pays a fair price for a stock. I can’t tell you how many times I have invested in a stock that has dropped almost immediately. Since incorporating DCA into my investing, I have stabilized my price per share for each of my stocks, despite the added commissions.

One way to dollar cost average without paying commissions is through direct stock purchase plans, as mentioned earlier. By setting up automated investment options (which most plans offer), investors can purchase stocks monthly in smaller chunks. For example, instead of investing $600 in a company once, investors can contribute $50 monthly for a year and get the same results. Purchasing a stock 12 times per year will make sure you are paying a fair price for a stock.

What is a Dividend Reinvestment Plan (DRIP)?

According to Investopedia, a DRIP is “A plan offered by a corporation that allows investors to reinvest their cash dividends by purchasing additional shares or fractional shares on the dividend payment date.”

For most dividend investors, setting up a DRIP is a great way to increase the value of their investment with no action required. Depending on the stock and/or the brokerage firm, most dividend reinvestment plans allow the investor to purchase shares with no commission or fees. This can drastically cut down on expenses often required to build and maintain a profitable portfolio of dividend stocks.

Types of Dividend Reinvestment Plans

Believe it or not, a couple of different types of dividend reinvestment plans are available. One allows the investor to purchase stock directly through the company, while the other requires a third party to invest.

Here are two popular methods for DRIP investing.

  1. Company Managed – Several companies run their own dividend reinvestment plans. These companies usually allow the investor to buy shares of their company directly through them without a broker. They also allow investors to buy partial shares, which can be a great investment if you don’t have a lot of capital. Popular companies like McDonald’s Corporation and Procter & Gamble are just a few of the many publicly traded companies offering this service.
  2. Brokerage Account – Most online discount brokerages allow customers to reinvest their earned dividends back into the stock at no cost. The incentive for the broker is to keep its current clients by offering this feature while the investor gets a discount on the expenses they will have to pay. Setting up a DRIP through an online broker usually takes just a few minutes to complete, making it an easy-to-use investment tool.

Advantages of DRIP Investing

Many successful income investors use dividend reinvestment plans on at least a few stocks in their portfolio. A DRIP is generally easy to setup, which makes them a popular feature for investors.

Here are a few other advantages to DRIP investing –

  • Purchase Fractional Shares – If an investor receives $20 from a dividend payment and the stock’s share price is $40, a DRIP makes it possible to purchase .5 shares. This allows the investor to continue building their position by reinvesting all of their dividend payments immediately into the stock without having to wait to buy a full share.
  • Automated Stock Purchase – These types of plans can be set up to reinvest any dividend payments into the stock automatically. The investor requires no action, making it a nice option for those of us with hectic lives. It generally takes less than 5 minutes to set up this feature with an online broker.
  • Commission Free – A great thing about dividend reinvestment plans is that they generally don’t require any commission be paid. Most online brokers don’t charge any commission fees when an investor decides to reinvest their dividends back into shares of the stock. This is great for the investor as they can lower the overall costs and the broker who gets to hang onto a customer longer by offering this feature.

Disadvantages of DRIP Investing

Using DRIPs can help investors automate their dividend reinvestments while lowering the costs of commissions and other fees. There are many advantages to setting up dividend reinvestment plans but also a few disadvantages.

Here are a few disadvantages of DRIP investing –

  • Diversification – Setting up a DRIP for the long term can prevent an investor from having a diversified portfolio. The investor must monitor stocks in their portfolio to ensure any dividends should automatically be reinvested.
  • Initiating New Positions – Many investors use the income they generate from dividends to initiate a new position in their portfolio. Using a DRIP prevents this from happening as all the income is reinvested back into the same stocks, leaving no money to open positions in new stocks.
  • Tax Tracking can be a Hassle. You need to keep excellent records of your transactions if you invest with DRIPs outside of a tax-advantaged retirement account like a Roth IRA. Making multiple stock purchases each year can give you a very different cost basis for each lot of stocks you own. You can alleviate this hassle by investing in an IRA or another tax-advantaged account, using a brokerage such as Ally Invest, which offers tax management software, or keeping excellent records.

Dividend Investing Tools – Using Data to Choose the Best Dividend Investments

Investing in the stock market can often feel like a full-time job if you don’t watch yourself. There is so much information about the stock market and individual companies is buzzing around. From financial analysts predicting where the market is heading, to daily news on individual companies – it can be hard to keep up on your research.

While I do spend a lot of time each month researching the overall market and individual stocks, I have also leveraged a couple of tools to help me along. Some of these tools help me save time while others save me money. Some of these investment tools are tangible and others are more of an investment strategy.

I thought it would be helpful to list a few of these tools that save me time and money building my investment portfolio. Here are 6 tools that are helping me build my dividend income portfolio.

1 – Personal Capital – Free Online Portfolio Manager

I recently started using Personal Capital to track my net worth, asset allocation, and portfolio holdings. This free online money management tool can automatically aggregate financial data like credit card balances, savings and checking account balances, and your investment holdings.

Similar to Mint, Personal Capital can simplify your life by giving you an overall view of your personal finances. Users simply sync up their financial accounts with Personal Capital and the tool does the rest.

After using the tool for just a short time, I have already found plenty of benefits for tracking my dividend income portfolio. Since I hold stocks through multiple online brokers (ie. Fidelity, Ally Invest, CapitalOne, etc.), Personal Capital allows me to look in one place to check up on my portfolio instead of having to login to multiple accounts.

Personal Capital offers both online access as well as through mobile apps. Setting up an account is free, only takes a few minutes, and has saved me a ton of time in just a few weeks. You can get a free Personal Capital account here.

2 – Microsoft Excel

While Personal Capital helps simplify how I track my dividend stocks, there are plenty of things it cannot do. I use Microsoft Excel to track my dividend stock holdings and to calculate important ratios related to my portfolio. For example, I use Excel to calculate my current yield on cost as well as my annual dividend income. These are two important calculations that every dividend income investor should know.

Each month after I make my monthly automatic investments and receive dividend payouts, I update the spreadsheet with these transactions and let the spreadsheet do the rest. Even with all the different online financial apps, I still find value in using spreadsheets as tools to build my portfolio.

3 – Automatic Investment Plans

Since I am still in my allocation phase of building a dividend stock portfolio, I like to use automatic investment plans. Every month I invest small chunks of money into a variety of stocks (8 right now) at either no or very low costs. This tool helps to diversify my portfolio by allowing me to spread my investment dollars around each month. It is also a great way to dollar cost average your stocks and it saves me a ton of time each month.

A few online brokers offer automatic investment plans but not all of them. Other options include using a transfer agent (see below) or a platform like LOYAL3 (see below).

4 – Dividend Reinvestment Plans (DRIP)

Another tool I use is setting up DRIPs on my dividend stocks. Setting up a DRIP on your investment tells your broker to reinvest any dividend payments from a stock back into more shares of that same stock. This tool helps me save time since reinvestment happens automatically. It also allows me to buy partial shares of a company to keep my investment compounding sooner rather than later.

5 – Transfer Agents

These are third-party entities used by publicly traded companies to keep track of investors who own their stock. Instead of buying stock directly from a company, investors can use a transfer agent to handle the transaction.

One transfer agent that I use every month is Computershare. I invest in companies using direct stock purchase plans and DRIPS through this transfer agent. Instead of buying stock directly from the company or through one of my online brokers, I buy partial shares monthly using Computershare.

Depending on the company, investors can also set up automatic investment plans when buying stock. In some cases, the company in which you are buying shares in will even cover any commissions or fees. I currently invest in 3 different companies each month through Computershare which allows me to slowly dollar cost average into a stock. This method of buying stock also helps me save time each month and in many cases saves me on investment fees and commissions.

It is important to note that a company will only use one transfer agent, which may or may not be Computershare. A few other common transfer agents include – American Stock Transfer & Trust Company, BNY Mellon Shareowner Service, and Wells Fargo Shareowner Services.

Final Thoughts on Dividend Investing

Investing in dividend-paying stocks can be a great opportunity to create a new source of income. Many income-producing stocks range from monthly paying REITs to traditionally stable blue chip stocks. Once an investor decides to begin investing in income stocks, they must understand several ratios, such as dividend yield and yield on cost. These ratios can help investors analyze stocks they are considering buying or selling.

Do you invest in dividend paying stocks? What experiences can you share – good or bad?

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  1. Fred Hayse says

    I think your infatuation with yield on cost has little value. If you buy a stock at $100/share yielding 4% at the time of purchase and the stock price doubles to $200, the current market yield drops to 2%. What action are you taking by knowing that you are earning 4% on cost versus 2% based on current market prices? Probably nothing if that is your main criteria. In reality, as long as the tools you use to pick stocks remains valid, you would be better off selling the stock, taking a capital gain of $100 and buying $200 worth of a new different stock (assuming no taxes are paid) that generates the 4% that you used as part of your original criteria to buy the original stock in the first place. I’d rather be making $8 in dividends instead of $4 in dividends, any day.

  2. lily says

    I am still convinced that I am happier and getting better returns with low-cost passive index funds than when I used to trade individual stocks.

  3. Jon @ Money Smart Guides says

    I’ve heard of the Dividend Aristocrats but not the Dividend Champions. I’ll have to check it out. It does make sense to follow closely as you mentioned, a company can cut its dividend and the Aristocrats list won’t let you know about it until the end of the year after missing out on possible dividends.

  4. Bryce @ Save and Conquer says

    Hi John, If I were younger and 100% invested in the Total US Stock market, I would have received a 30% return last year. That is including the fund expenses of 0.05%. Since I also have quite a bit of my portfolio in a short-term bond index fund for downside protection, I received more like an 18% return last year. I am sure there are many people who had better returns, but there are many who did worse.

    Looking at the historic return since 1926 for a 50/50 stock/bond portfolio, the average annual return over the past 88 years is 8.3%, with 17 years out of the 88 years having a negative return.

  5. Bryce @ Save and Conquer says

    LOYAL3 looks kind of interesting, but I am still convinced that I am happier and getting better returns with low-cost passive index funds than when I used to trade individual stocks.

  6. Kirk Kinder says

    I am so glad to see this message out there. Too many investors look at the current yield and leave it at that. Investors who accept a lower initial rate but buy companies that constantly increase dividends end up with much better portfolio returns. I love some of the indices like the Dividend Aristocrats that focus on companies that have raised dividends for 25 years straight. There are only 60 of them out there, and they are the bellweathers such as Coke, JNJ, Proctor and Gamble.

    Just make sure that the dividend growth rate does not exceed the earnings growth rate. That usually ends up with a dividend cut in the future or a misallocation of capital.

  7. Pat S says

    Awesome article. A great resource for dividend histories is dividend.com. It can provide a chart which displays what the historical dividend increase for most companies has been. Using this, you can basically see how if the dividend increases continue and the P/E remains somewhat reasonable, the stock price increases as well. Coupled with compounding reinvested dividends, and you have, what I believe to be the recipe for an index crushing portfolio with very low volatility.

  8. Robert says

    I absolutely love dividend paying stocks. I especially like large-cap stocks that pay a steady dividend, but may have been beaten down by recent short-term news.

    I also follow a portfolio of dividend paying insurance companies on my site that have had great returns over the last 9 months.

  9. Andrew @ Money Crashers says

    Dividend paying stocks seems to be all the rage lately. With the tough economy and stock market, these stocks at least offer some form of “guaranteed money” that hopefully will accompany a rise in the stock price. The one thing I’d keep in mind that is risky with these stocks is that there is always the chance the dividend will be cut or erased…meaning you’ll not only lose out on the dividend, but most likely also a drop in stock price. That’s why it’s good to look into the dividend history of a company and to see it’s consistency.

  10. Scott B says

    Good article. When I first starting buying dividend stocks I was looking at the highest dividend paying stocks in the 20%+ range. I couldn’t believe I was getting 25% dividend yield on my money! It seemed too good to be true and it was. On one stock I received dividend payments for a couple of quarters until the stock price dropped 90% and the dividend was cut to 1%. Lesson learned – don’t just look at the dividend yield when there are other important factors to consider.

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