By Due. Originally published at ValueWalk.
Would you like to have an extra $1,000 per month? Even if you’re a minimalist, I think most of us would jump at this opportunity. And, for good reason.
An extra grand a month could totally transform your life. In addition to paying off financial debt, you could also invest in your retirement or buy life insurance with this extra cash. Or, with your newfound financial freedom, you could finally make much-needed home repairs, take a class to enhance your skills, or take that vacation you’ve been talking about for years.
And, considering that 56% of Americans can’t pay for a $1,000 emergency expense, this money could be used to build a considerable emergency fund.
However, you’re not going to suddenly end up with $1,000 per month — unless you inherit money or win the lottery. It has to be earned.
Now, your first thought could be that you should find a second job. If you’re facing a financial crisis or are working toward a short-term financial goal, this is the right move. On the other hand, you may find this takes you away from your family, friends, or hobbies. Plus, juggling both a full-time job and an internship can be exhausting. Consequently, if your performance or productivity plummets, you could in essence risk your primary source of income.
With that said, what are your realistic options for earning an extra grand each month? One of my favorites is through a passive income.
What is a Passive Income?
Making passive income requires little effort on your part. Often, passive income is referred to as ‘earning money while you sleep’ because it requires almost no involvement. This isn’t the case in every situation, however. However, hopefully, you’ve got the jest on what a passive income is.
However, there is a myth about passive income that needs to be busted. Passive income is assumed to be so easy that anyone can earn it within the weekend. Once that’s done, you just sit back and wait for the money to come following in.
Truth be told, a lot of work needs to be done upfront. Your passive income sources still need to be updated and maintained even after the initial legwork is completed. One example is blogging.
Once it’s up and running and producing a steady revenue stream, it can make a lot of money. But, building a blog to that level takes a lot of effort. And, even if you reach that level, it still needs to be managed. If anything, it’s semi-passive. Although this is an excellent income source, it is not really passive.
But, that’s not true with dividends.
What is a Dividend (And Why They Rock)?
If you want a truly passive income, then let me introduce you to my good friend dividends.
For those who aren’t acquainted with my friend here, dividends are payments companies make to shareholders as a way of sharing profits. Investors earn a return on stock investments through dividends, which are paid on a regular basis.
Let me also add that not all stocks pay dividends. You should choose dividend stocks if you want to invest for dividends, however.
All right, that’s great. What makes dividends a passive income though?
Again, most passive income sources will still need a little TLC every now and then. I already talked about blogging. But, property rentals are another example of a semi-passive income. If you don’t maintain your rental, it’s going to depreciate and become loss appealing to renters.
In the current era of exceptionally low interest rates, dividend income is in a league of its own. It is possible without any effort to create a portfolio of stocks that generates a steady return of 3%-4% per year.
There is no better example of a truly passive investment today than that.
Now, let me be real. To reach the desired level of income takes a lot of capital. If you invest wisely, however, you can earn a generous income — even $1000 per month in dividends. And, as soon as it’s up and running, you won’t have to lift a finger to get it going.
Besides being a legitimate passive income, I’m a big fan of dividends for the following reasons.
Even though I’m talking about dividends, dividend stocks can also generate capital appreciation. After all, they’re stocks, and the value of stocks tends to go up over time.
If you’re lost, let’s take Pepsi as an example. Right now, the stock pays a dividend of almost 3% per year. The current share price is about $172. But if you purchased the stock 10 years ago? You could have done so at less than $65 per share. The stock value has more than doubled in 10 years, and you have earned 3% in passive income over that time.
In other words, dividend stocks have the advantage of not only providing a steady income. But also the benefit of capital appreciation. By doing so, you can protect your investment from inflation and also make sure it grows over the long run.
As such, dividend stocks are among one of the very best investments you can make, and are one of the strongest recommendations for the foundation of your portfolio. Dividend stocks should be a core investment, even if you own other investments.
Dividend stocks vs. growth stocks.
Now, I gotta quickly fill you in on dividend stocks. Unlike growth stocks, dividend stocks tend to rise less in price than growth stocks. Why? As their name implies, growth stocks are all about growth. Most pay little dividends if any at all. All profits are instead reinvested into the business to expand revenue and profit.
In fact, over the past decade, growth stocks that don’t pay dividends have produced some of the best results. The most notable example is Amazon (AMZN). In the past 10 years, its stock price increased from $170 per share to more than $3,000 now, but it doesn’t pay a dividend.
You won’t get income from these stocks until the day you sell them, so you may want to hold a number of them in your portfolio. The appreciated value will come at that point. But, for now, it’s just paper gain.
In short, investing in dividend stocks is a better choice if you’re looking for passive income.
Favorable tax treatment.
Dividend-paying stocks offer tax benefits in addition to yields above those of interest-bearing securities.
Dividends are treated as ordinary income by the Internal Revenue Service. If qualified for the long-term capital gains tax rate, however, they aren’t taxed.
Dividends on the stock must be issued by a US corporation or by a foreign corporation with stock trading on a US exchange in order to qualify as a qualified dividend. To qualify for dividends on a stock, you must also own it for at least 60 days.
For qualified dividends the tax rates are as follows:
- If you have a taxable income of less than $78,750, you pay 0%.
- If you’re single and earn more than $78,750, but less than $434,550, or if you’re married filing jointly, or if you’re a qualified widow, you’re eligible for a 15% tax exemption.
- Taxes are charged at a rate of 20% of your taxable income that exceeds these thresholds.
In any case, if you hold dividend stocks in qualified tax-deferred retirement plans, the lowered (or nonexistent) taxes won’t matter. Holding them in a taxable investment account will give you a big tax advantage though.
Where to Find Dividend Stocks
Dividend-paying stocks tend to be issued by large corporations with established financial records. Or at least those that pay higher yields consistently over time.
They are also commonly known in most cases. Either they have popular products or services, or they’ve been around for a long time and have built a strong reputation. They tend to be popular with investors, too, due to all those qualities and their dividends.
Now, when it comes to dividend stocks, companies can choose between different dividend types. The most common types include:
- Cash dividends. These are the most common dividends. Companies typically deposit cash dividends directly into shareholders’ brokerage accounts.
- Stock dividends. In addition to paying cash, companies can also share additional stock with investors.
- Dividend reinvestment programs (DRIPs). With DRIPs, dividends are reinvested into the company’s stock, often at a discount, so investors receive their dividends back sooner.
- Special dividends. Shareholders receive these dividends when their common stock goes up in value, but they do not recur. When a company has accumulated profits over years but does not need them at the moment, it will issue a special dividend.
- Preferred dividends. The dividends paid to the owners of preferred stock. Stocks that are preferred function less like stocks and more like bonds. Most preferred stock dividends are paid quarterly, but unlike dividends on common stock, they are typically fixed.
With that out of the way, let me go over the three basic ways to invest in dividend stocks.
Start with dividend aristocrats.
At present, all stocks in the S&P 500 index offer a yield of 1.37%. To begin, you might want to focus on stocks that are paying even higher dividends.
Stock screener software can certainly assist with finding those companies. But, there’s a much easier method.
You can find many of the best and most stable dividend stocks on a list called Dividend Aristocrats, which includes some of the highest-dividend paying stocks. At the moment, the list includes 65 companies.
In order to be considered a Dividend Aristocrat, a company must meet specific criteria. Among these criteria are:
- At least 25 straight years of increasing dividends to shareholders.
- An established, large company is generally listed on the S&P 500, rather than one that is fast-growing.
- The company must have a market capitalization of at least $3 billion.
- The value of daily share trades for the three months prior to the rebalancing date must have averaged $5 million.
However, just because a stock is a Dividend Aristocrat doesn’t automatically make it a good investment. There is no guarantee that a company is permanently on the list just because it is on the list. The list is usually altered every year, as some companies are added and others drop.
Dividend aristocrats: What to watch out for.
In the case of Dividend Aristocrats, two factors need to be considered:
- The ratio of dividends paid out. This is the percentage of net profits a company pays out to shareholders in dividends. It is unlikely that the current dividend is sustainable if this number approaches or exceeds 100%. The optimal dividend payout ratio is between 50% and 60%.
- A dividend yield that is excessive. A dividend yield of 3% to 4% is the average for Dividend Aristocrats. In some cases, higher pay may be due to a company’s share price falling, such as 6%, 8%, or more. This could indicate a company is in distress.
Either situation can indicate a dividend reduction is a real possibility. If that happens, not only will your dividend yield be reduced, but the price of the stock will almost certainly fall.
High dividend exchange-traded funds (ETFs).
Investing in ETFs can be a good alternative to holding individual stocks. For example, you can invest in dividend-paying ETFs.
- Vanguard High-Dividend Yield ETF (VYM) – currently yields 2.99%, with an average return of 10.45% over the past decade.
- SPDR S&P Dividend ETF (SDY) – has an overall return of 10.23% over the past ten years and a dividend yield of 2.91%.
- Schwab US Dividend Equity ETF (SCHD) – pays dividends of 3.69%, and has returned 14.61 percent over the past 9 years (founded in October 2011).
These three funds not only show double-digit returns for the past decade but also have current yields much higher than interest-bearing investments.
Although you might not become wealthy in the way that high-flying growth stocks do, these funds provide steady, reliable returns. Long-term investors should consider this kind of investment as the centerpiece of their portfolios.
Real Estate Investment Trusts (REITs)
Essentially, REITs are mutual funds that invest in real estate instead of stocks. However, not any kind of real estate will do. Real estate investment trusts invest mostly in commercial properties, including office buildings, retail space, warehouses, and big apartment buildings.
A minimum of 90% of their income must be distributed to shareholders as dividends as well. The net rental income and the capital appreciation distributions of sold properties make up this portion. For simplicity, dividends are usually paid on a monthly basis by REITs.
Here are some dividend-paying REITs to consider:
- Brookfield Property REIT (BPY) – current dividend yield of 7.54%.
- Kimco Realty Corp (KIM) – current dividend yield of 3.26%.
- Brandywine Realty Trust (BDN) – current dividend yield of 6.59%.
Bear in mind, however, that REITs have not had good long-term performance in the past few years. In spite of paying consistently high dividends, both Brookfield Property REIT and Kimco Realty Corp have experienced major share price declines over the past decade.
On the flip side, Brandywine Realty Trust showed the best capital appreciation, holding constant over the past decade.
Where to Invest in Dividend Stocks
Want to earn a passive income with dividends? The following investment platforms allow you to invest in dividend stocks or high dividend ETFs. As an added perk, each gives you the option of commission-free investment in stocks or ETFs.
On either your computer or your mobile device, you can trade stocks and ETFs using the Robinhood app. This is also one of the only investment apps that offer trading options as well as cryptocurrency.
In spite of the fact that Robinhood is primarily designed for self-directed investors, it provides sufficient company information to identify dividend stocks and track them. Dividend yield, price-earnings ratio, and 52-week high and low prices all fall into this category.
The company is currently giving you the chance to earn up to $500 in free stocks by referring friends who open accounts on the app. A stock can be worth anywhere from $2.50 to $200. But, come on. That’s free money just for signing up.
Webull works a lot like Robinhood. This company offers commission-free trading of stocks, ETFs, and options, and it has mobile trading capabilities. If you’re on the move constantly, then this is the platform for you.
Webull does not require a minimum initial investment. But funds are required for investing.
Moreover, it does offer both traditional and Roth IRA accounts, which makes it a better alternative to Robinhood. The reason dividend stocks are ideal for retirement accounts is that they provide long-term growth in addition to income.
You will also receive interest on any invested cash held in your account at Webull.
Unlike Robinhood and WeBull, M1 Finance allows you to purchase stocks through portfolios called “pies,” which are comprised of many stocks and/or ETFs.
There are pre-built pies available, but you can customize your own with the stocks and ETFs you want. If you prefer, you can make a pie out of each of your favorite Dividend Aristocrats, or even pick all 65 stocks. It’s entirely up to you how many pies you want. Dividend Aristocrats can be held in one account, growth stocks in another, or sector ETFs in another.
When you have created one or more pies, M1 Finance provides you with another advantage. Your pie will be managed robo-advisor-style, with periodic rebalancing to make sure your allocations remain on target, and even dividends reinvested. You can then sit back and watch your investment grow once you’ve selected your stocks or funds.
Ah. The best kind of passive income you could ever ask for.
How to Build a Portfolio That Will Make $1,000 Per Month in Dividends
For new and small investors, this is a significant barrier. I mean you’d need about $400,000 with a yield of 3% to make $1,000 per month in dividends.
But how do you get to $400,000?
To begin, let’s take a look at things from a different perspective.
Investing in dividends is, by definition, a long-term endeavor. The goal isn’t growth, and most certainly not explosive growth. Rather it’s all about a steady income that hopefully will appreciate over time. So, you’ll need patience and constant investing if you want to make it a long-term investment.
The first step, then, is to consider the amount you plan to invest and set up a regular schedule. Suppose, for example, you buy 10 shares of a particular stock each month, or invest $500 per month. Over time, you can gradually add many thousands of dollars to your investments every year.
This results in a positive outcome. With your monthly purchases, you will be able to utilize dollar-cost averaging. A method like that greatly eliminates the impact of stock price fluctuations or the timing of the end of the market. Every month, you will just invest the same amount.
And, best of you all, you just let compound interest work its magic.
If you are investing $500 per month in a growing portfolio of dividend stocks with a 10% return, including dividends and capital appreciation, you would be investing $6,000 per year. Investing at the same level for 21 years will mean you’ll have over $400,000 — even if you never increase it.
Dividend Reinvestment Plans commonly called DRIPs, make this possible. These are often offered by the brokerage firm where you hold the stocks. With DRIPs, dividends are used to buy more shares of the same company automatically.
The Bottom Line
Dividend stocks don’t get the same buzz as growth stocks do. The thing is, they’re the kind of investments that build both permanent wealth and passive income. What’s not to like about that?
For retirement portfolios, dividend stocks are especially enticing. Investing in these funds will not only allow you to build wealth over decades but will also provide a steady flow of income when you retire. As the stock prices rise in value over time, you can use the dividend income to cover living expenses.
You can choose to receive $2,000, $3,000, or even $5,000 in dividends per month, even though I have been talking about $1,000.
You’ll need a much broader portfolio for that. However, if you are planning to become wealthy or retire with a seven-figure account, you might as well earn a decent income while you’re at it. To build a portfolio large enough to generate $1,000, or more, per month in dividends, you must combine regular contributions, dividend reinvestment, and capital appreciation.
Article by Jeff Rose, Due
About the Author
Jeff Rose is an Iraqi Combat Veteran and founder of Good Financial Cents. He teaches people wealth hacking. He is a frequent on CNBC, Forbes, Nasdaq and many other publications. He is author of the book “Soldier of Finance: Take Charge of Your Money and Invest in your Future” where he teaches how he escaped from $20,000 in credit card debt to a life of wealth.
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