Dividends –The Old Way of Making Money

When I taught Adult Ed I’d tell the story of a grandma who was terrified of the stock market and  lived on the interest from the bank or credit union. As time went on and interest rates, with the help of Chairman Greenspan, were lowered, grandmas everywhere had to start dipping into principal to keep the same amount of income coming in the door. Basically they were spending themselves into poverty because if rates ever did recover grandmas would have less money to earn the new rates and would still have to pull principal out of savings to make ends meet.  And the end result would be that eventually grandmas would be packing their bags and moving in with you-know-who.

On the flip side were folks, pre-mutual fund age, who while working, bought individual stocks to grow their money and then at retirement turned to dividend paying stocks for income. 

Today buying dividend stocks for income is a lost art for individual investors. More and more people are turning to mutual funds and ETFs for income rather than building portfolios with quality stocks that have a history of providing consistent dividends.

Before we begin on what to look at when buying an income producing stock there are investors who still don’t have a clue as to where dividends come from. I get the question from a lot of people when I suggest an equity based mutual fund or a stock, ‘How much interest does this pay?’ It doesn’t.

Stocks pay a dividend and not interest. Dividends are a portion of the profit earned by the company and declared to be paid to shareholders by the board of directors of the company. Interest is what institutions and companies pay for the right to borrow someone’s money. You don’t own anything when you hand the bank money for a certificate of deposit. What you are doing is loaning them money for a specific period of time and at a specific loan interest.

Not every stock pays a dividend and not every dividend is equal in value and safety as every other dividend.

Before you buy a stock for dividend income you should do a little homework.

• How consistent is the dividend payment history?
• Has the company increased its dividends and how often?
• What is the company’s cash flow?
• Is the dividend in line with other companies in the same industry?
• Is the company involved in litigation that may hinder future dividends?

Buying a mutual fund that invests in dividend paying stocks is a good alternative to choosing individual issues. You will earn less but have greater safety and diversification. Historically dividends have accounted for about 40% of the total wealth creation in equities which makes investing in those stocks appealing both short and long-term.

The bottom line is that even if you have a portfolio comprised solely of mutual funds it doesn’t hurt to add some quality dividend paying stocks to increase your total yield.

If you have questions for Paul call 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.