Dividend Investing Supplements Passive Income

By Staff

I’ve written before about the various passive income streams available, but up until now I have largely ignored the concept of dividend investing. That was until the recession caused interest rates to drop to levels that don’t even keep pace with inflation. As I searched for higher yields, I was introduced to the concept of dividend investing.

A Quick Introduction to Dividends

If you are not a stock investor, or regularly dig into your mutual fund statements, you are probably like me and are unfamiliar with the concept of dividends. Basically, a dividend is a cash payout by a company to its to stockholders. Companies that raise a lot of cash, and are fairly stable (meaning not growing rapidly or in financial trouble), reward stockholders by returning a sum of cash to them on a per share basis, usually in quarterly payments.

Most companies raise or lower their dividend after quarterly earnings results are released. A handful of companies have long histories of increasing dividends over time, and now offer a healthy dividend yield.

Where to Find the Best Dividend Stocks

AT&T often appears on lists of best stocks to own for dividend investors. They have a long track record of paying dividends. In fact, they have increased their quarterly dividend for 26 consecutive years. While there is no such thing as a sure thing, this kind of long track record is what I’ll look for when selecting single stocks for our dividend portfolio.

How to Calculate a Stock’s Dividend Yield

AT&T (T) last declared a quarterly dividend of $0.42 per share, or $1.68 annually, in December 2009.  At the time of this writing, their stock price is 24.86 per share. Dividing the annual dividend dollar amount by the current share price provides the annual dividend yield of 6.75%. Not too shabby, considering most online savings accounts are yielding around 1.30%.

AT&T Pays for My Netflix Membership

That sounds a little strange, so let me explain how this all works. AT&T doesn’t really pay for my Netflix membership, but the dividends I receive from AT&T stock alone cover that expense. That’s the way I look at dividend investing. Each time I add to my portfolio, and increase the amount I receive in dividends, it covers another expense. One day, it is not unthinkable that dividends alone could cover all of our basic living expenses.

I recently signed up for an online brokerage account and purchased 80 shares of AT&T to begin my dividend portfolio. Every three months, AT&T will return a dividend of $33.60 ($0.42 per share dividend x 80 shares). That works out to about $11.20 a month. After taxes, that is just enough to cover my $9.62 monthly Netflix bill. As long as AT&T continues to pay the dividend (and Netflix keeps its price steady) I’ll have our movies-at-home budget category covered.

Dividend Investing for Early Retirement

Last year, I wrote about the concept of an early retirement freedom chart to track passive income, active income and monthly expenses. It was an idea I got from my favorite personal finance book, Your Money or Your Life. In the book, the authors advocate creating a wall chart to track monthly expenses, actively earned income (from an employer, for example), and passive income (interest accumulation, dividends, etc.). I’ll actually track this in Excel, where I do most of my budgeting. I’ll plot our income, expenses and passive income each month.

As our income increases and we can invest more money, our passive income will rise. If we reduce expenses, or keep them flat, eventually the passive income line and monthly expenses line will intersect at a cross-over point. It is at this point where our living expenses are covered without the requirement to earn more active income. Hello financial independence!

The book’s author achieved this point by investing in Treasuries, but this was back in the early to mid 1990s when they were yielding an attractive six to seven percent. These days, that rate is much harder to find.

We plan to use a mix of cash-based accounts and dividend stocks to get to our cross-over point. We’ll diversify into 10-15 stocks across a range of sectors from utilities to telecom to consumer goods, and try to add a little to our positions each pay day. Slow and steadily, we will be building a portfolio of dividend stocks with the potential for lifestyle-sustaining income for the years ahead. That’s an exciting prospect!

If you are interested in learning more about dividend investing, I highly recommend the book The Ultimate Dividend Playbook from Morningstar (written by Josh Peters).

Disclaimer: Please do not buy any stock mentioned here at Frugal Dad just because I mentioned it. Do your own research and buy positions that match your risk tolerance and income needs. One more note, single stock investing is risky, so aim to keep single stocks a relatively small percentage of our overall portfolio. We have 100% of our retirement funds in mutual funds, but I’ll dabble in single stocks for dividend investing.