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Mustard Seed Money

Mustard Seed Money

The Magic of Dividends

May 18, 2018

THIS POST MAY CONTAIN AFFILIATE LINKS. PLEASE READ MY DISCLOSURE FOR MORE INFO.

 

Growing up, I associated dividends with old people on a fixed income.  Why would I ever consider buying boring blue chip stocks that paid a quarterly dividend? Instead, I could invest in disruptive tech companies that might drastically alter the way that we live.

 

I thought that I could easily become rich like all the tech investors out there in Silicon Valley.  I thought that all I needed to do was find the “right” company and then ride the wave to riches.

 

The problem though was that I was terrible at selecting companies.  I kept picking losers. I wanted badly into companies like Theranos that was disrupting the blood testing market.  However, that company in particular ended up committing massive fraud. Furthermore, who would have thought that the internet book seller, Amazon, would become one of the world’s largest companies?  Just goes to show you– it’s not always easy to pick winners.

 

After being discouraged by my losers, I began to question successful friends and family to learn how they invested.  Interestingly enough, not a single investor told me that they invested solely in technology companies. Instead, each made very small bets in technology companies, usually less than 10% of their portfolio.  Their higher concentrations were in dividend stocks and passive index funds with dividends.

 

What Is a Dividend?

Before we get too far, let’s make sure we’re working from the same definition.  A dividend is simply the portion of a company’s profits that the company divides up and pays to its shareholders.

 

By far, the most common type of dividend that companies provide to shareholders is a cash dividend.  Typically with a cash dividend, on the declaration date, the company declares its intention to pay the shareholders in cash on a date in the future.  

 

This future date is most commonly known as the payment date.  Pretty simple, huh? To ensure that you will receive the cash dividend, you must hold shares in the company by the ex-date, which is the day before the date of record.  The date of record is the day in which a company will look at its record to see who its shareholders are.

 

Dividends are usually paid out on a quarterly schedule.  However, there are some companies that make payments monthly, semi-annually or annually.  As you can imagine, companies that pay out monthly are often favorites of dividend investors, due to the steady stream of income they provide.

 

S&P 500

While it’s painful to admit now, it took me too long to see the light when it came to investing.  As I shared above, I thought that I was going to be this amazing day-trader, riding only the highs of my great stock picks.  The problem was, I had too many misses along the way.

 

It wasn’t until I started reading up on the foolishness of trying to beat the stock market that I began buying passive index funds, like the S&P 500.  

 

Now, I don’t have to worry if single stocks go up or down, or even if they plan to cut their dividend in the future.  With the S&P 500, I’ve seen my portfolio slowly rise over time. On top of that, without fail, I receive a quarterly dividend, just for holding shares of 500 of the largest companies in the U.S.

 

The S&P 500’s annual dividend yield is just under 2%, or roughly 0.5% each quarter.  With the price of the Vanguard 500 at $250 a share, that means that I receive roughly $1.25 each quarter.  

 

Who cares about a $1.25?  That’s chump change. Well, read on, and I’ll show why it’s so important to me.  

 

Related:  Here’s What a $10,000 Investment in an S&P 500 Index Fund in 1976 Would Be Worth Today

 

DRIP

Back in 2012, I decided to purchase 150 shares of the S&P 500 through my Roth IRA account.  After I made the purchase, I turned on the DRIP (Dividend ReInvestment Plan), which automatically takes the cash dividend that I would have received and reinvests the cash 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.  It’s grown by a little over 20%.

 

Can you believe that?  

 

I did nothing but turn on an automated function, and I essentially received 30 shares for free.  Each one of these shares now pays me $1.25 per quarter for a yearly profit of $150 a year, on top of the shares being worth close to $250.  

 

I can’t wait until when my yearly profit from the “free” dividends top the share price, which is currently $250.  When that happens, the dividend shares that I bought through the DRIP are essentially buying whole shares on their own.

 

Related:  Why a Dividend with a DRIP is the Best

 

S&P 500 Growth

One of the great things about the S&P 500 is since 1990, the average dividend growth is 5.9%.  For retirees that use the S&P 500 dividends to derive income, that means that their dividend income is outpacing the 2% historical average of inflation.  With a net gain of 3.9%, this means that they are receiving a nice bump in income every year, just by holding a diversified basket of stocks.

 

Related:  The Benefits of the S&P 500

 

Dividend Aristocrats

Some of you may have heard of an exclusive group of stocks called the Dividend Aristocrats.  These aristocrats have not only paid a dividend for the last 25 years, but they have also increased their dividends over these years as well.

 

Currently, there are 53 companies that meet the criteria of Dividend Aristocrats.  These companies typically attract investors who are dividend-hungry but want to know their dividend is safe to be paid and more importantly, will increase in the future.  

 

Rising Dividends

One of the things that I really appreciate about dividends is when the stock price goes down, most of the time, the dividend usually remains the same.  While most people worry when stock prices go down, I get excited knowing that the cash dividends that I receive from the S&P 500 will be reinvested to purchase discounted shares.

 

But what about when the Great Recession came around, and dividends were cut?

 

Yes, dividends did get cut, by nearly 20% from 2008 to 2009.  However, that did not exceed the 50% that the S&P 500 shares lost. In theory, my purchasing power rose by 37.5%.  That allowed me to buy a greater number of cheaper shares.

 

Playing It Safe

I know that FANG (Facebook, Apple, Amazon, Netflix and Google) are all the trendy picks these days.  

 

For every Facebook, there was a MySpace.

For every Apple, there was a Wang Computers.

For every Amazon, there was a Pets.com.

For every Netflix, there was a Kozmo.com.

For every Google, there was a Alta Vista.

 

The chances of identifying the next great winner is difficult.  Instead of guessing and wasting hours upon hours of research, I’ll take a good old-fashioned blue chip that pays a steady and reliable dividend.

 

Do you love dividends as much as I do?  Have you tried to figure out which tech companies will be winners and losers?  Why or why not?

Related

22 Comments

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Comments

  1. Ms. Frugal Asian Finance says

    May 18, 2018 at 8:02 am

    I see dividend income in a lot of PF bloggers’ the income reports. I think it’s a great passive income stream if we don’t lose money.

    Mr. FAF and I will start investing in stocks more after we sort out our mortgage and kids situation. Amazon is probably one of the biggest shocks this century. Who would have thought a platform for used books would become a tech superpower today. Life!
    Ms. Frugal Asian Finance recently posted…The Pain Of Home Ownership – Our $3,000 HeadacheMy Profile

    Reply
    • Mustard Seed Money says

      May 19, 2018 at 8:33 pm

      Amazon is so crazy to me. If anyone had that foresight to invest big in them, they are probably retired on the beach somewhere loving life 🙂

      Reply
  2. Tom @ Dividends Diversify says

    May 18, 2018 at 8:12 am

    When I was younger, like you, I thought dividends were for out of touch investors. Now I won’t buy a stock if it doesn’t pay one. Tom
    Tom @ Dividends Diversify recently posted…The Apple of Your Dividend EyeMy Profile

    Reply
    • Mustard Seed Money says

      May 19, 2018 at 8:35 pm

      Hahha…I’m the same way. There are very few stocks that I would buy without a dividend, although Berkshire Hathaway is one of the exceptions 🙂

      Reply
  3. Mr RIP says

    May 18, 2018 at 9:02 am

    I have mixed feelings with dividends. One one side they’re an edge against market crashes, but at the same time they’re a limitation on long term growth of a company. If I company can’t make better use of its money than to distribute to its shareholders it means the company is limiting its future growth. the reason why FANG companies have grown so much is that they don’t distribute dividends. Dividend stocks are like bonds. I would love to see a deep analysis on how would the 4% rule work if you invested in high yield dividend stocks alone.

    And I have a second, darker thought about DGI (Dividend Growth Investing). those who buy the “Dividend Aristocrats” essentially do that for the dividend growth of the company. Share price would drop by 90% if a company stops issuing growing dividends, no matter how solid its business is. My dark thought is “what if they’re going broke because they HAVE TO keep increasing dividends? Isn’t that what MADOFF did? Isn’t it a big Ponzi Scheme?”
    Mr RIP recently posted…Playing with FIREMy Profile

    Reply
    • Mustard Seed Money says

      May 19, 2018 at 8:38 pm

      I definitely hear you Mr. RIP. I think it’s interesting how Warren Buffett won’t issue a dividend for Berkshire Hathaway, but on the flip side loves to buy companies in his portfolio with dividends. His latest big tranche is Apple. I’ve never understood it but it seems to work for him 🙂

      Reply
  4. CJ says

    May 18, 2018 at 9:33 am

    What are your thoughts on investing a big chunk in a single stock that pays a hefty dividend like CYS? Current dividend is over 12%.
    CJ recently posted…10 Easy Money Hacks for People Who Hate Saving MoneyMy Profile

    Reply
    • Mustard Seed Money says

      May 19, 2018 at 8:42 pm

      I’ve found/heard that high yield dividends usually don’t sustain themselves for very long. So I’ve personally avoided them. For every winner there are usually 10 losers.

      Reply
  5. Dan says

    May 18, 2018 at 12:25 pm

    Back in the old days, there were broadly speaking two types of stocks – growth stocks and value stocks. Growth stocks typically do not pay dividends. The theory is they reinvest their dividends into their company and grow it. Tech stocks were growth stocks. These were stocks that you bought and hold with the intention of eventually selling it off at a handsome capital gain. Value stocks were older companies that didn’t have many growth opportunities left. They were successful but that was reflected in their dividend payments. They would trade within a smaller range and their dividends were steady. You bought these stocks and held them forever and reaped the dividends.

    You bought growth stocks when you were young and had time to let the share price appreciate. As you aged and approached traditional retirement age, you start selling growth stocks and buy value stocks.

    Speaking for myself, as I approach early retirement, I am willing to trade some growth opportunities for income certainty. I’ll be too young to draw social security or my pension so I would like a firm income stream to offset my core monthly expenses. The dividend aristocrats fill this need nicely.

    Reply
    • Mustard Seed Money says

      May 19, 2018 at 8:59 pm

      I really would be interesting to see how dividend aristocrats match up against bonds over the years. Might be an interesting study to see which is a better long term investment for retirees.

      Reply
  6. Rob @ Passivecanadianincome says

    May 19, 2018 at 10:14 am

    Nice man.

    Im a huge fan of dividend stocks and especially drips. It essentially does the work for you by constantly buying new stocks. Like you said with dividend investing a down turn in the market is actually better. (If the dividend remains intact)

    Loving the cashflow dividends bring.
    Cheers
    Rob @ Passivecanadianincome recently posted…Technology and FinancesMy Profile

    Reply
    • Mustard Seed Money says

      May 19, 2018 at 9:11 pm

      Yeah, that is always a big if during a down market. When I was buying I was constantly looking for companies that had enough cash flow to cover the dividend in good times and bad 🙂

      Reply
  7. Dividend Diplomats says

    May 19, 2018 at 11:51 am

    I mean, I love this article. But that’s probably because I’m a dividend investor myself. There is nothing sexy about dividend investing. You know, there was a time in my life where I enjoyed chasing the next great stock, the one that will disrupt its industry like you. But after meeting Lanny and learning about dividend investing, investing in a steady stream of dividend income just made sense to me. I’ll take that over investing and playing the market value appreciation game, where at any moment any value you had in that sexy up and coming stock could disappear.

    I can understand why some people don’t like it, especially if their mentality is short-term rather than long-term. To be a successful dividend investor, you must remain patient because the MV’s aren’t going to swing as drastically. And guess what, that’s exactly why i love it.

    Thanks MSM!

    Bert

    Reply
    • Mustard Seed Money says

      May 19, 2018 at 9:17 pm

      Glad you enjoyed the article Bert!!! Like you slow investing is better for my risk tolerance level than picking the next growth stock 🙂 Plus there’s a greater margin of safety!!! Thanks as always for stopping by.

      Reply
  8. xrayvsn says

    May 20, 2018 at 12:36 am

    I always flip flop my views on investing based on dividend yield. Don’t get me wrong, I love passive income and dividends currently play a decent percentage of that.

    My issue is with the potential tax drag they create as most of these dividends, I believe, are taxed at your income tax level because they are ordinary dividends. I happen to be at the top tax bracket so obviously that’s a big chunk of change going back to Uncle Sam.

    In my accumulation phase which I’m currently in (I’m 47), ideally a stock like Berkshire Hathaway would be ideal because it does not throw out dividends so there is no tax hit until you sell at much more favorable capital gains level.

    In the decumulation phase I think dividends would play an increasingly important role as potential steady quarterly passive income.

    Also any advice purchasing around an ex-dividend date? I would think if I knew a company was about to declare a dividend date, it would be wiser to buy shares after that (otherwise I am putting capital in and getting some returned almost immediately but then taxed.

    Reply
    • Mustard Seed Money says

      May 22, 2018 at 9:09 pm

      I think I’ve read that theoretically stocks drop once the ex-dividend hit to account for the dividend. So theoretically, I think it would be a good time, although timing the market is not something I’ve been very good at 🙂

      Reply
  9. Late Bloomers Money says

    May 20, 2018 at 8:33 am

    Thank you for visiting my site. awesome article! Dividends are a great source of passive income. I personally like to follow Warren Buffett’s principles, which is mainly investing in companies with long-term prospects and also undervalued. It’s been little difficult these days to find undervalued companies because a huge increase in index investing across the board. The problem with index investing is it can potentially increase the price of underperforming stocks..

    Reply
    • Mustard Seed Money says

      May 22, 2018 at 9:10 pm

      Very true, some of the dogs get pulled up, which I guess they say why active management will swing back against index investing…eventually. We’ll see if they can root out some of the under performing dogs along the way 🙂

      Reply
  10. freddy smidlap says

    May 20, 2018 at 11:17 am

    i learned the risks of some dividend stocks the hard way through the school of hard knocks. i owned an oil refiner mlp and a couple of oil drillers who slashed dividends that weren’t sustainable. it was like getting an mba in life and i learned and changed. i know the personal finance community largely eschews individual stocks but i like the idea of one big winner carrying me to wealth. i also made a non-DIY move and bought a stock advisor newsletter a couple of years ago which pointed me to some great companies. i don’t just blindly buy the rec’s but i ended up with nvda, shop, ma, amzn and some others with great total returns. i’m on the lookout for FUTURE div aristocrats who are profitable and may have initiated dividends in the past 5 years and increased them. you gotta have the will and be enough of a nerd to pay attention to them but i have time and really enjoy it. otherwise indices will get you there fine. nice article.

    Reply
    • Mustard Seed Money says

      May 22, 2018 at 9:13 pm

      Thanks for sharing Freddy!! While I’ve had some success over the years picking individual stocks, I don’t have the time that I once had. Sounds like you have gotten a great formula to pick winners which is awesome to hear. I love hearing how people gain wealth, as no two people are alike 🙂

      Reply
  11. Brian Harper says

    May 20, 2018 at 7:41 pm

    Thanks for the article. For passive income I’m willing to take the risk, but I’m young and sill learning about dividends. My financial adviser told me to be careful because my dividend payments can be taxed twice, so I still need to learn a little more before I invest.
    Brian Harper recently posted…WordPress.com Vs WordPress.orgMy Profile

    Reply
    • Mustard Seed Money says

      May 22, 2018 at 9:16 pm

      Thanks for sharing Brian!!! There are definitely things that I am constantly learning as well about the stock market. It’s an interesting beast 🙂

      Reply

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