Investing 101 – Dividend Investing

It was brought to my attention the other day that I may have jumped into things before explaining to my readers what everything actually was, especially with dividend investing.  I tend to do that.  I just go off on tangents or talk about things that seem normal to me and are just way off the beaten path for everyone else.  Sorry about that.

So what is a dividend?  According to the all knowing Investopedia, a dividend is a “distribution of a portion of a company’s earnings.”  So when we talk about dividends, we’re talking about the money that we receive on a monthly, quarterly, or annual basis just for owning a share of the company.  For example, may issue a dividend of $0.25 a share a year.  If the stock has a value of $10.00 a share, that means the dividend is a 2.50% return on your money. Better than your savings account!  However, if the stock rises to $50.00 a share, the dividend is now a return of 0.50%.  Better than most savings accounts but not as good as before.

However, this huge capital appreciation doesn’t often happen with dividend producing companies.  You see, companies with dividends tend to be more mature companies with established revenue streams and earnings.  In fact, Standard and Poor’s produces a list of the “Dividend Aristocrats,” a list of companies that have increased their dividend every year for at least 25 years.  These are companies we all know, like AFLAC, Chevron, Target and many others.  These companies are ideal investments for the everyman (or woman) because they have easy to understand products and businesses.  You look at them and you just know what they do!  Even better, their stock prices do not fluctuate as much as others.  Because they are big, blue chip stocks with dividends to their shareholders, they tend to be more stable.  They go up less in the good times and they go down less in the bad times.  They’re an ideal investment for someone who wants better returns than a CD or savings account but is still too risk averse for a tech stock or an early IPO.

So how do we use this knowledge of dividends and what they are to start a dividend investing program?  Well, with dividend stocks, you have two possibilities: you can take the dividends as income or you can reinvest them back into the company tax free.  In dividend investing, you’ll typically do the latter.  Why is this?  Well, it helps your portfolio in two ways.  The first way, and I think the most important, is that you’re taking that 2.50% from our first example and you’re using it to buy more stock in the company, which will produce more dividends which will buy more stock which will produce more dividends etc etc.  Add in the capital appreciation and you can have some serious growth on your hands.  In fact, using the handy dandy dividend reinvestment calculator we are able to see just HOW much this can help.  If we were to invest $10,000 in Aflac in January of 1980 and you chose to not reinvest the dividends, you would have just over $1.4 Million today.  However, if you reinvested the dividends, you would have $1.65 Million.  An extra $250K is nothing to sneeze about when you only put in $10K (if adjusted for inflation, it would be the equivalent of $28K invested today).

The point here is that dividend investing can help build a strong portfolio if you start when you’re young and use your iron nerves to avoid selling the moment you have a miniscule profit.  If you do this, your dividend invest can eventually turn into dividend income for retirement, something everyone wants!

Let me know if there are other topics or subjects which you need explained.  Passing on my knowledge is what this is all about!