Why a Dividend with a DRIP is the Best

dripWhen I was young and naive, I thought that dividends were for old people living on social security.  Why would I want to buy blue chip stocks that paid a steady dividend when I could buy innovative technology companies that were changing the world?  

 

I then began to ask friends and family how they invested.  I couldn’t find any successful investors that invested solely in technology.  Sure, I read about many rich investors that were able to make concentrated bets in tech companies that were a fraction of their net worth pay off.  But when it came to everyday successful investors, all of the ones that I met had a high concentration in dividend paying stocks.

 

I wish I could say that I followed my own research and only bought dividend paying stocks.  I didn’t.  I tried to be like the rich tech investors and bought tech companies trying to get rich quickly.  I was an idiot.  I know.  Five years chasing the elusive tech stock that was going to make me rich overnight was a huge waste of time in hindsight.  Instead of constantly researching the next great industry, I should have been investigating companies with solid balance sheets.

 

What is a Dividend?

A dividend is derived from the Latin word “dividendum”, which means things to be divided.  In non-Latin terms, this means the company is dividing up some of their profits to provide to their shareholders.  

 

DRIPThe most common type of dividend is a cash dividend.  Normally with a cash dividend, the company will declare their intention to pay the shareholders in cash on a date in the future.  This is most commonly known as the declaration date.  If you are holding shares in the company by the ex-dividend date, ie the record date, you will be entitled to the cash dividend on the payment date.  Dividends are normally paid out on a schedule normally quarterly.  However, some companies may make payments semi-annually or annually.  Most income investors gravitate towards companies that pay quarterly due to the steady stream of income throughout the year.  

 

S&P 500

I almost exclusively buy stocks that pay dividends.  Specifically, I am heavily weighted towards the S&P 500.  Without fail, every three months, I get super excited as I know that the S&P 500 is going to pay me just for holding shares.

 

DRIPRight now, the S&P 500 annual dividend yield is around 2%, or 0.5% each quarter, of the S&P 500 share price.  I currently have S&P 500 shares in a Vanguard ETF (VOO), so essentially I receive $1.00 each quarter.  I know what you are thinking.  Big deal, who cares about $1.00.  I do, and read on to see why.

 

I bought 150 shares of VOO about four years ago.  Since then I turned on a DRIP (Dividend ReInvestment Plan), which automatically takes the dividend that I would have received for the share of my stock and allows me to automatically reinvest the dividends by buying more shares of the S&P 500.  Not only has the S&P 500 gone up, so have the number of shares that I own.  

 

I recently looked at the number of shares in my account, and it’s grown by a little over 10%.  Can you believe that?  I did nothing but turn on an automated function, and I now own 18 shares more.  Each one of these shares now pays of $1 per quarter for a yearly profit or $72 a year on top of the shares being worth close to $200.  

 

I am eagerly waiting for the time when the dividend shares that I bought through the DRIP are able to buy whole shares on their own.  

 

Another really great thing about the S&P 500 dividend is the average growth is 5.87%.  For retirees that are using the S&P 500 to derive income, that means that the dividend is outpacing the 2% historical average of inflation.  With a net gain of 4%, this is a healthy bump in income every year for the privilege of holding on to a diversified basket of stocks.

 

Dividend Aristocrats

Within the S&P 500, there are an exclusive group of stocks called the Dividend Aristocrats.  These aristocrats have not only paid a dividend for the last 20 years, but they also must have increased the dividend to the shareholder each year to remain on the list.  

 

Currently there are 52 companies that meet the criteria as a dividend aristocrat. These companies normally attract investors that are dividend-hungry but want to know their dividend is safe to be paid in the future.  Over the past 10 years, NOBL, a stock symbol that is comprised of Dividend Aristocrats, has outpaced the S&P 500 by over 7%.  This makes sense since many individuals sought refuge during the Great Recession in blue chip stocks that paid a steady dividend.

 

DRIPFinally, the thing that I love most about dividends is when the stock price goes down, but the dividend remains the same or goes up.  While most people bemoan when stock prices go down, I rejoice knowing that I have a long-term horizon and that the S&P 500 will potentially rebound.  When the market is down, to me, this is the perfect time to buy S&P 500 shares on sale.

 

I know what you are thinking though.  When the S&P 500 dropped during the Great Recession, dividends were cut.

 

You are correct that dividends were cut.  However they were not cut as much as you think.  Even when the dividend on the S&P 500 was reduced by 19% from 2008 to 2009, that still did not exceed the 50% that the S&P 500 shares lost.  My purchasing power rose by 37.5%, which allowed me to buy more and more shares cheaper and cheaper as the market fell.  

 

While I know that FANG (Facebook, Amazon, Netflix and Google) are all the rage with the tech types.  The chances of identifying the next great winner are difficult.  Instead of guessing and wasting hours upon hours of research, I’ll take a good old-fashioned blue chip that pays a steady reliable dividend.

 

Do you love dividends as much as I do?  Why or Why Not?

Mustard Seed Money

Welcome to the website. A mustard seed is a very small seed but astonishingly grows very large over time. My hope is that through your financial journey that your small investment in time, money and faith will grow beyond anything that you could ever imagine.

2 Comments

  1. I love dividends! In fact, all of the single stocks that I own throw off dividends. It is always fun to get that quarterly payday for doing nothing at all but owning stock. A few FANG types can be sprinkled in to a portfolio for diversification, but overall I would rather have dividend stocks for the majority.
    Mr Defined Sight recently posted…Happy Thanksgiving!My Profile

    • I’m with you. Having a steady dividend each quarter is much more appealing than the 1% chance that a high flying stock pays off. I view those type of IPOs more like lottery tickets than true investments.

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