Wednesday, April 13, 2011

Reinvesting Dividends Pays Off

I consider myself a fairly frugal person. I like cutting recurring expenses, which is why I drive a ten year old car and only have a discounted cell phone with the lowest plan possible. Saving money and investing in quality dividend stocks is just one of the strategies I utilize to increase my dividend income. Cutting expenses however can only go so far however. That’s why generating extra income is so important to me. Besides the dividend income from my portfolio, I often look for brokerage deals in order to find brokerage bonuses or free trades. I also like teaching young people how to save and invest for their future.


Back in 2008 Sharebuilder had a promotion, where investors who put $50 in their account and executed one trade could earn a $50 cash bonus. I shared this deal with a young dividend investor who invested $40 in a real estate investment trust called Realty Income (O), which pays monthly distributions to its shareholders. The company was well known for having raised distributions every quarter since going public in 1994. He paid a $4 commission on the trade and as a result generated a $0.20/month income stream from this small investment. He subsequently received the $50 cash bonus in a few weeks, which meant that he was essentially playing with the house’s money. The investor did sign up for the dividend reinvestment program, which meant that each month these $0.20 deposits were automatically reinvested into additional shares. The company has another $50 promotion right now as well.


I had forgotten about this account, until I spoke with this investor when I was preparing their taxes for 2010. I noted that their monthly distributions had increased to $0.25. This was a cool 25% increase in dividend income for just 3 years, during one of the worst recessions since the Great Depression. With the automatic dividend reinvestment he was able to purchase shares in Realty Income during the worst market conditions, as well as throughout the market’s steady climb over the past 2 years.

Albert Einstein had once said that compounding of interest was one of the biggest wonders in the world. With dividend reinvestment, investors could take advantage of this compounding for wealth accumulation. In addition to that, by selecting companies whose stocks regularly raise dividends, investors could essentially turbocharge their returns in the long run.

For my 40+ positions I typically collect the dividend income until it reaches a certain threshold, and then I reinvest it selectively in the most attractive dividend stocks at the time of purchase.

Companies for long term dividend investment, which fit my entry criteria right now include:

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. This dividend aristocrat has raised distributions for 37 years in a row and has a ten year dividend growth rate of 17.80% per year. Yield: 2.80% Check my analysis of the stock.

The Coca-Cola Company (KO) manufactures, distributes, and markets nonalcoholic beverage concentrates and syrups worldwide. This dividend aristocrat has raised distributions for 49 years in a row and has a ten year dividend growth rate of 10% per year. Yield: 2.80% Check my analysis of the stock.

Air Products and Chemicals, Inc. (APD) provides atmospheric gases, process and specialty gases, performance materials, equipment, and services worldwide. The company has raised distributions for 29 years in a row and has a ten year dividend growth rate of 10% per year. Yield: 2.50% Check my analysis of the stock.

The Chubb Corporation (CB) , through its subsidiaries, provides property and casualty insurance to businesses and individuals. The company has raised distributions for 46 years in a row and has a ten year dividend growth rate of 8.30% per year. Yield: Check my analysis of the stock.

McDonald's Corporation (MCD) , together with its subsidiaries, operates as a worldwide foodservice retailer. The company has raised distributions for 34 years in a row and has a ten year dividend growth rate of 26.50% per year. Yield: 3.20% Check my analysis of the stock.

The Procter & Gamble Company (PG) provides consumer packaged goods in the United States and internationally. The company operates in three global business units (GBUs): Beauty and Grooming, Health and Well-Being, and Household Care. The company has raised distributions for 54 years in a row and has a ten year dividend growth rate of % per year. Yield: 3.10% Check my analysis of the stock.

The moral of the story is to save a lot, buy quality dividend growth stocks at the right times and reinvest dividends when you can.

Full Disclosure: Long all stocks mentioned above

This article was included in the Carnival of Personal Finance #305

Relevant Articles:

- Reinvest Dividends Selectively

14 comments:

  1. All else being equal, remember that the compounding of dividend reinvestment depends upon the dividend frequency! A company paying $.25 quarterly would compound faster/larger than a company paying $1.00 only annually.

    ReplyDelete
  2. I like your blog, and I enjoy your analysis. I have a question - since you like to avoid costs, wouldn't a simple DRIP be cheaper (no transaction fee) as opposed to collecting the dividend, then buying and paying for commissions?

    Furthermore, as you already own MCD, and you believe it's fairly valued, would you leave that DRIP on?

    Thank you for all your articles and advice. Really appreciate it.

    ReplyDelete
  3. The link to sharebuilder does not work? Is sharebuilder now part of ING?

    ReplyDelete
  4. I've got a Sharebuilder account and since they allow for partial shares I just let them reinvest all dividends automatically. I've always wondered if it would be better to take the dividends as cash and reinvest more selectively in to whatever dividend stock is most attractively valued. I don't have a lot of shares of any one company so I usually end up getting less than .1 share each time a dividend is paid. I always figured it would be better to just let the dividends add to my current position until my dividend income was more significant. Any thoughts? Thanks!

    ReplyDelete
  5. For the most part, I reinvest everything. I make it automatic this way. I don't have to think. If I have other cash, I use that to make strategic (timely) purchases when stocks are cheap(er).

    I try to only own companies that a) pay dividends quarterly and b) pay increasing dividends year-after-year.

    This, coupled with DRIPs, makes my investing compounding machine run pretty smoothly.

    Hopefully in another 20 years, my dividend income will pay for my home property taxes, my heat, my hydro and any home improvements I want to make to my house every single year. The good news is, I'm already 25% of the way there thanks to dividend paying stocks :)

    Good post.

    ReplyDelete
  6. Yes, sharebuilder is part of ING now. Also a tip for all of you Sharebuilder users - if you have a costco account, there is a promotion going on where you get money back and rebates. The link is sharebuilder.com/costco90.

    ReplyDelete
  7. Anonymous- Select stocks with increasing dividends and keep the drip going with Sharebuilder. Unless you are dealing with a good amount of dividend payments, even a $4 commission will kill you over time.

    DGI- I am surprised you don't have you holdings in drips (or Sharebuilder like account). I think I understand your logic by selecting the stock to get the reinvestment (I assume stocks with the greatest dividend growth rate). How do you handle the extra cost?

    ReplyDelete
  8. Anon1,

    I agree that the frequency of compounding is also helpful.

    Anon 2,

    My broker used to offer 10 free trades/month. However starting this month they no longer do this. The issue with DRIPing is that sometimes reinvesting automatically might not be a good idea, particulalry if a certain stock you drip in is overvalued. I would much rather pay a commission, than overpay for a stock.

    What I have done is instead of spending $250 or $500 for each position per month, I would double my size.

    Radman,

    the link to sharebuilder works for me.

    Last Anon,

    If you are dealing in fractional shares, it might make sense to do it automatically. But if you have around $10,000 you might want to be more selective.

    ReplyDelete
  9. I do the exact same thing! I selectively re-invest dividends. Unless I'm absolutely certain about the company, I take the dividend and reinvest elsewhere.

    ReplyDelete
  10. I reinvest all dividends that I have at Sharebuilder. Why wouldn't you reinvest your dividends. I also have a Scottrade account that I buy stocks that don't pay dividends. These two brokerage are good companies. Never keep all your money at just one brokerage. If you would like to try Scottrade for free then Scottrade will give you 3 free tradesjust to try them out. Scottrade referral code: IXFV9382 will get you 3 free trades when you open any type of account.

    Lyn

    ReplyDelete
  11. I use Sharebuilder and also Scottrade.I use Sharebuilder for my dividend stocks and Scottrade for my non-dividend stocks. Never keep all your money just a one brokerage.(no matter how good they are) If you need a nudge to open a Scottrade account, Scottrade has a referral code to get you starte with 3 free trades.

    Scotttrade referral code: IXFV9382

    Happy investing.

    Lyn

    ReplyDelete
  12. Doesn't sharebuilder charge a good chunk for a small investment? Somthing like $4? That could amount to 8% of a $50 investment.
    I use Computershare, which, depending on the company, charges nothing.
    Of course, not all companies use Computershare so check BNY (soon to be computershare), Wells Fargo, or check with the company for their direct agent.

    ReplyDelete
  13. Does Scottrade offer an automatic dividend reinvestment program?

    ReplyDelete
  14. I started a DG account with 10,000. My plan is to wait until there is a balance of 1,000, either from dividends or additional deposits and then either buy new stocks or re-invest. Is there a common wisdom regarding automatically re-investing the dividend?

    ReplyDelete

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