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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.
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.
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.
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
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.
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.