Dividend Investing: How and Why to Do it

Own a stock and get paid to wait.

That’s the idea of dividend investing. While you wait for your portfolio to appreciate (ideally) you also receive a regular stream of income.

Dividends give you a leg up, too. Over history, dividend-paying companies have given investors excess returns with less volatility – dividend stocks have been great stocks to own. I’ll go through a few ways to get access to high-yield, dividend-paying companies.

Dividend investing

Dividend Stock Funds

The fund industry has loved the move to dividend stocks. More interest begets more money, and then eventually more products. Here are a couple ways to get broad exposure to dividend stocks in your portfolio with exchange-traded funds:

  1. SPDR S&P Dividend (SDY) – This fund is a great pick because it owns many of the highest-yielding companies in the well-known S&P 500 index. When you buy this ETF, you have exposure to big names in the high-yield sector including AT&T and Clorox Company. This fund yields 2.85% right now, compared to 2% for the whole S&P 500 index. With 86 different stocks in the fund from all industries, you can be sure you get good diversification while earning an above-average yield.
  2. Vanguard Dividend Appreciation (VIG) – Vanguard’s Dividend Appreciation ETF is a way to play companies with growing dividends. Compared to the SPDR fund, this fund looks forward, rather than backward, to determine which dividend-paying companies will increase their dividends in the future. The fund holds 147 stocks in various industries with key names like Coca-Cola and Proctor and Gamble. The good news is that it is also cheap to own, with a cost of .13% per year in fund fees. However, one word of warning: because this fund looks for dividend growth, it doesn’t offer much yield today. If you bought it today, you’d get a yield of 2.17%.

Funds are great for quick and easy picking. For smaller investors who cannot tolerate a lot of transactions and cannot afford to diversify on their own, these two funds are excellent. They’re great, too, for people who simply want to “buy and hold” and “get paid to wait!”

Individual Dividend Stocks

For the enterprising investor who wants to go look for their own stocks, a few industries may strike your fancy. Dividend-paying companies tend to be concentrated in a few, slow-growing industries, but over time investors who have reinvested the dividends have enjoyed good returns. Here are a couple good places to look:

  • Utilities and railroads – These two industries have been around since your great-great-great-great grandparents, and they’ll probably be around for much longer than that. While neither grow particularly fast – face it, these aren’t exactly something cool like Facebook or Google – they are reliable dividend payers.
  • Consumer stocks – Think of all the stuff you buy on a day to day basis, convenience products. Everything from soaps to dish washing detergents (Proctor and Gamble) to soda and chips (Pepsi) provides a stream of cash to established businesses. Since these firms have very few opportunities to expand, they pay out much of their earnings in the form of dividends to shareholders. Plus, as with utilities and railroads, these stocks are going to be around for a long time to come – their products are necessary for living on planet earth.
  • Real estate – Real estate investment trusts allow you to buy real estate on the open stock market and participate in all the rents their bring in. While you shouldn’t expect the same profitability from owning a REIT as you might expect from a single-family home you buy yourself, you won’t get late night phone calls to replace the plumbing, either. Real estate investment trusts are very popular with people who want income before capital gains, and they are treated very favorably for tax purposes.

As always, you should be careful when selecting individual dividend stocks. Seek to diversify so that your income isn’t tied to a single sector. Real estate provides big cash flows, but 2009 was awful for real estate investors. On the other hand, 2009 wasn’t necessarily a bad time to own utilities, since people still kept their lights on and used their air conditioners.

Remember, the key to dividend investing is time. These stocks are not meant to be bought today and sold tomorrow – they’re for investors who want to be paid routine and regular cash dividend payments over the long haul. You won’t become an overnight millionaire by investing in dividend-paying companies, but dividend companies have made many millionaires over periods spanning decades. If you’re in the market for the long haul, and through thick and thin, dividend paying companies are a great place to be. Over time, they have rewarded investors with above-average returns.

11 Responses to Dividend Investing: How and Why to Do it

  1. Great overview! I have been in a few consumer staples for a while and taking advantage of some of the dividends. It’ll be interesting to see how REIT’s do in the near future with the growth we’re seeing in the housing industry.

  2. If there’s one kind of stock market investing I can get on board with, it’s dividend investing. Cash flow is king and dividend paying stocks actually increase your cash flow. You just have to hope the value of the stock doesn’t crash while you’re waiting for your payments.

  3. In my view, the most important thing with a dividend stock is the dividend growth. Pick them right and you will get an ever increasing stream of passive income that will grow faster than inflation. Pick them wrong and you could be sitting with a high yielder that’s primed for a dividend cut. Focus on revenue, earnings growth and cash flow, which should then drive good dividend growth.

  4. Thanks for the great overview, I wasn’t aware of dividend funds until today and had only been doing a bit of investing in individual dividend stocks. I’m going to definitely considering dividend funds in the future.

  5. I have stocks in the railway and consumer industry. They both are dividend yielding stocks. Next step is to get some REITs. I pretty much only look at stocks that give dividends to its shareholders.

    Now my only problem, trying to find the extra money to buy more of them! 😛

  6. I am a big dividend investor. I also make sure I auto reinvest my dividends since I really dont NEED the cash right now, although I am sure I could find something to spend it on. I read about a dividend income investor once who bought stock into his telecom, utility and other companies whose services he uses and then used the dividends to in turn pay his monthly bills from the respective company. In effect, the companies where paying their own bills for him, great!

    • That dividend investor is taking advantage of a lovely arrangement. Working for your money is okay but letting your money work for you is even better.