Incorporating dividend paying stocks into your portfolio is a good way to give yourself a little extra cash each year. When this goes back into your portfolio, the compound interest grows faster. At first, this won’t seem like much, but over the period of ten or more years, things add up very quickly. Let’s take a look at how this works, and how you can use it to your advantage.
When a company has a dividend, qualified stockholders receive that money back to them. They can choose to have that money come back to them as a check, or they can have it put right back into their account. Having a check is nice if you want the extra cash, but putting that money right back into your holdings is far more lucrative over time. Let’s say you get a dividend check for $100 from a company four times a year. By putting that money right back into your account, that $100 now becomes part of what earns interest. It will increase the return on the stock when prices go up, and the extra $400 per year will create even higher dividends in the future.
If you have $10,000 in your portfolio, and you are gaining 3% in interest each year, you can expect to have your money grow to $18,207 in 20 years. Not bad at all. But, if you were to add a few dividend paying stocks to that portfolio, and they added an extra $400 per year to the total, you could expect that total to be even higher after 20 years: $29,028. That’s more than an extra $10,000, and you didn’t have to add a single penny out of pocket to that investment. In reality, that number would be a few hundred dollars higher, too, since this doesn’t take into account the slightly higher dividend earnings that you would see each year. In fact, your dividend–if they were able to match that $400 number–would give you more than the interest itself would earn you thanks to the little bonus they provide plus the interest that they would earn on top of that. This becomes extremely valuable to you over time.
That’s why it’s so important that you don’t be dismayed by the tiny profits that they provide at first. If you only see a few dollars here and there at first, that’s okay. It will keep getting better, especially if you mention to your financial advisor that this is something that you want to do.
Do be careful when using this investing strategy. There were many funds last year, namely mutual funds and a handful of specific retirement accounts, too, that had too many dividend bearing holdings and the funds could not legally put that money back into the fund itself. What ended up happening is that investors received checks for the money that their investments had earned. This is a seemingly good thing, but those investors had to pay taxes on them right away, which defeats some of the point of having a retirement-specific account. Annuities rarely will ever fall into this category, especially if you focus on fixed and index based annuities. If this is a strategy that you wish to employ, have a professional go over your choices with you so that he or she can show you the best way to use dividends to your advantage. There are plenty of ways to do this without owning individual stocks, but that is another possibility. Funds are ideal for this because they provide the safety net of diversification, all while providing a steady stream of dividend payments from different sources throughout the year.