Dividend stocks can provide you with regular income, or with the ability to boost your portfolio through DRIPs.
One of the investing ideas that I find intriguing is dividend stocks. I'm slowly starting to build a dividend portfolio that could, in time, offer regular income. While dividend stocks might not offer the same low-cost investment opportunities as index funds and ETFs, they still provide their own opportunities. Most of my money (including in my Roth IRAs) are in funds. However, the idea of building an income portfolio with dividend stocks intrigues me.
What are Dividends?
Dividends are payouts made to shareholders of certain stocks. Dividends represent a portion of profits that are paid out to shareholders, rather than reinvested in the business, or used in some other way. Dividends are calculated according to how many shares are owned. You might be paid 15 cents a share each quarter. So, if you own 100 shares of a dividend paying stock, you will receive $15 each quarter, or $60 a year.
Dividends can be increased or cut, depending on how the company feels it is doing. Dividend aristocrats are companies that have raised their dividends every year for at least 25 years. Some dividend aristocrats have raised their dividends for more than 30 consecutive years. Choosing these stocks can provide you with a measure of stability as you build your dividend portfolio, since there is a good chance (but not a certainty), that dividends will rise.
Investing in DRIPs
While you can certainly receive regular payouts for owning dividend stocks, it's also possible to have the dividends automatically reinvested. Companies that allow you to reinvest dividends automatically offer what are known as DRIPs (Dividende Re-Investment Plans). These DRIPs essentially allow you to get stock for free. Instead of receiving that $15 a quarter, your payout will be used to buy more shares — including partial shares. That way, if the company's stock is selling for $30 a share, you can still buy 1/2 a share with your $15 dividend payout.
Many companies allow you to participate in DRIPs fee-free. This means that you don't have to pay the regular transaction fee to reinvest your dividends. When you purchase a share of a dividend paying stock through dollar-cost averaging or some other method, you will pay a fee. However, most DRIPs — even those you participate in with the help of online brokers — don't charge fees. This can help you build your nest egg faster, and result in a more valuable portfolio later. The potential capital appreciation increases since you are adding more shares.
Building an Income Portfolio
Of course, you can also use dividends to build an income portfolio. Instead of reinvesting dividends, you can receive those regular payments. You can add dividend stocks to your portfolio, paying attention to yield and dividend growth in order to find options that are likely to grow over time. You can use dividends for income if you plan your portfolio carefully. However, it's important that you realize that significant income doesn't happen overnight.
You need to realize that it can take seven to 10 years — or longer — to build an income portfolio using dividend stocks. Most people have to start small, buying only a few shares at a time. As a result, it takes time to build up enough shares to make a real difference in your income. That $15 a quarter mentioned above isn't going to provide you with the income you need for retirement or for other purposes. You have to work at it little by little.
And, of course, you have to understand that you could lose money. Even dividend aristocrats are subject to future cuts, as well as capital losses. You could invest in a dividend stock only to have it tank at the same time dividends are being cut, resulting in losses. As with all investing, you need to carefully consider your options, your investment goals, and do your due diligence in research.
Image source: RangerRick via Flickr
This post is part of Women's Money Week 2012. For more posts about Saving & Investing see Saving and Investing Roundup. You can also read my post for Women's Money Week, Three Critical Types of Savings, which was specifically created for #WMW2012.