Investing for Income: How to Set Up a Dividend Stock Portfolio that Returns 7%
Earlier this year I started wondering why I was plowing money into my savings account when I was earning a paltry 1% return. I actually got a little angry about it, knowing that in years past, you could get something like 5% on a savings account. Now, the rates hardly keep up with inflation!
I decided that I could sit around and blame the government policies that led to the low rates or do something about it. So I hunted around for other investments that would provide a better return and eventually settled on three. The first is Treasury Bonds, which I discussed in another article. The second is municipal bonds, and the third is high yield dividend stocks.
I still keep some money in my savings account but the diversity of adding the stocks and bonds has increased my overall rate of return significantly. Keep reading to find out how you can do the same. And you don't need a lot of money to get started!
What is a Dividend?
A dividend is simply a portion of a companies profit that's paid to its shareholders. A profitable company has several choices for what to do with the money they earn. They can invest it back into the business by buying plants, equipment, hiring new employees, or even buying other companies in order to grow. They could also put their money in the bank or invest it. Finally, they can pay it out to shareholders in the form of dividends.
Generally, established companies that are well beyond their early growth years (think McDonalds) will pay dividends. These established companies are motivated to pay dividends to make their stocks more attractive to investors.
Small growth companies will invest back into the company. Investors in a growth company don't expect dividend payments because they believe that the value of the company, and therefore the value of the stock, will increase as the company grows.
There are other companies that are known for paying high dividends as well. The most well-known are Real Estate Investment Trusts (REIT's). By law, REIT's are required to pay out 90% of their profits as dividends. Investing in a REIT is akin to investing in real estate so be careful in this volatile market.
As an investor, you can choose to purchase stocks of growth companies, hoping that they'll be the next Microsoft or Google or you can be more conservative and invest in established companies that pay healthy dividends. Basically, the dividend is a return you can pretty much count on and if the stock price goes up too, you'll have an even higher return on your investment.
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How to Decide Which Stocks to Buy
It goes without saying that choosing the stocks you purchase is extremely important. Luckily, there are many tools and tips available to help. Before you start your research, read these 5 rules for selecting your dividend stocks:
- Diversify: Don't purchase all of your stocks in one industry. Try to buy at least 5 different companies, all in different industries. That way, if one type of stock falters, you still have the others to rely on. For example, if you have $1000 to invest, you'd invest $200 in each of 5 companies in 5 different industries.
- Know the Company: Don't just buy what's recommended on the various financial websites. Do your research and know the company you're investing in. What products does it sell? Do you use their products or services? What has been your experience with them? What is the long-term trend for their industry? Remember, you're buying a company.
- Know the Dividend History: Companies that have a long history of paying out dividends and increasing them nearly every year are the best to invest in. These companies are known as the Dividend Aristocrats.and have increased dividend payments for 25 years straight. It's very easy to find out which companies fall into this group by doing a search on that term.
- Don't Go for the Highest Yield: If you use a stock screening tool to find the highest yielding companies, don't just select the top five highest and call it a day. You also need to look for companies that are stable and have a solid stock price. Otherwise, you could be taking on too much risk for that yield.
- Buy and Hold: Over time, as your dividends are reinvested back into the stocks you purchase, you'll own more shares. More shares translate into higher dividend payments since you're paid a specific amount per share you own. Eventually, you'll build up quite a nest egg. When you're ready to retire, you can use the dividend payments as income to live on rather than reinvesting them.
Now that you know the rules, you can start your search. There are many tools to use to find information on companies. Try Yahoo Finance and their stock screener tool. With the screener, you can set your criteria for yield, stock price, and more and it will return a list of companies. You can then put their stock symbol into the search engine and get a wealth of information on the company. Also, as mentioned before, you could start with a list of Dividend Aristocrats and then do your research on those companies that interest you.
How to Buy Dividend Stocks
There are a couple of ways to purchase dividend stocks. The first is to open a brokerage account with a brokerage like Vanguard, Fidelity, eTrade, Scottrade, or many others. These companies usually have minimum investment requirements and will charge a fee per trade. Do your homework to figure out the best option for you. The second way to invest is by using Share Builder via ING Direct. This service allows you to invest in stocks or mutual funds with no minimum opening balance. It's great for new or smaller investors.
Example of a Dividend Portfolio
Here's an example of a dividend stock portfolio. This is not an endorsement of these companies. You'll need to do your own research and decide what's right for you before investing. You can see though that they come from a variety of industries, including healthcare, food service, tobacco, telecommunications, and mortgage REIT's. The overall return on a portfolio like this is much higher than what you'll get on a savings account.
Johnson & Johnson (JNJ)
Annaly Capital Management (NLY)