Many investors rely on their investment portfolios to generate the income they need to make ends meet. For them, dividend stocks are a natural choice, because they offer regular payments of dividend income, as well as the chance to enjoy share-price gains when the company's underlying business is successful. Especially for those who are retired and living on fixed incomes, the ability to benefit from a combination of stock appreciation and reliable income is huge, and many top dividend stocks also have good track records of boosting their payouts on a regular basis as well, adding to their attractiveness.

Most dividend stocks have one drawback for income investors, though: They tend to make their dividend payments only on a quarterly basis. That's fine for the company, but it doesn't always work out well for shareholders who have monthly income needs. A few dividend stocks, however, have figured out that meeting their investors' needs can be a smart move, and they've therefore chosen to make monthly dividend payments. Although income investors naturally prefer the highest dividend yields they can find, the highest-yielding monthly dividend stocks aren't necessarily the ones with the safest dividends. Shareholders have to seek out top dividend stocks not based solely on yield but also on other features, such as whether they offer dividend reinvestment plans. Later in this article, we'll reveal five top monthly dividend stocks, but first, let's take a closer look at why monthly dividends are attractive and what you have to do to avoid potential mistakes in choosing stocks.

Glasses, calculator, money, and a notebook with word Dividends written in it, all on a tan-colored flat surface.

Image source: Getty Images.

What's a dividend and how does it work?

A dividend is an amount of cash that a company chooses to pay to its shareholders. For each share of stock that you own, the company will pay you a certain amount, and the more stock you own, the greater your total dividend will be. Most companies pay dividends on a regular schedule, with quarterly payments (coming four times a year) being the most common.

The mechanics of how dividends get paid out are a bit tricky to understand. Companies set a date, called the record date, on which they'll look at the current owners of shares and pay dividends to them. A second date, called the ex-dividend date, marks the first day on which purchases and sales of shares will not give the buyer the right to that particular dividend payment. So if the ex-dividend date of a stock is June 30 and I buy the stock on June 25, then I'll get the dividend payment. But if I buy it on July 1, then I won't receive the dividend payment -- the previous owner will still get the dividend, even if it gets paid out several weeks later.

Many investors look at the dividend yield as an important metric. The dividend yield is equal to the total annual dividend payments divided by the stock price. So if you own a stock priced at $100 per share and it makes quarterly dividend payments of $0.75 per share, then the dividend yield will be 3% -- $0.75 times four quarterly payments in a year equals $3, divided by the $100 per-share price.

Why do investors like monthly dividends?

At first glance, it might seem completely unimportant how often a company pays a dividend. As long as the total amount of the dividend payment is the same over time, whether a company parcels those payments out on an annual, semiannual, quarterly, or monthly basis won't have an impact on how much money goes into your pocket.

From the company's perspective, making dividend payments less often can be a positive. Some companies justify paying dividends less frequently by saying that the expenses of processing each individual dividend can add up, and so making four quarterly payments costs roughly four times as much as making just a single payment annually.

Meanwhile, investors generally fall into two categories with respect to their needs for dividend income. If you don't actually need cash from your portfolio, then you won't value frequent dividend payments as much. That's especially true for those who plan to participate in dividend reinvestment plans, or DRIPs for short. These plans take the dividends that you would have received and, instead, reinvest them into additional shares of the company's stock. This has the benefit of gradually increasing your position in a given stock, but it's not as critical whether those reinvestments happen once, twice, four times, or 12 times a year.

Monthly dividends work best for investors who have regular monthly living expenses and like having income that comes in on a matching schedule. Sure, you can put your quarterly or annual dividend income into a separate bank account and budget it out over three or 12 months. But it's a lot more convenient just to see the money coming in every month and then to arrange to have it put where it can go toward paying your bills in a timely manner without any extra effort.

Why you shouldn't just pick the stocks with the highest yield

If you need portfolio income, the temptation is to go with the investments that will generate as much of it as possible. You can find dividend stocks that have extremely high yields compared to prevailing interest rates. Yields of 10% or more aren't unheard of, and many more stocks pay dividends in the 5% to 10% range. With most fixed-income investments like bonds and bank CDs paying a whole lot less than that in interest, those high-yielding dividend stocks look awfully tempting.

But there's danger in concentrating entirely on the dividend stocks with the highest yields. In many cases, a yield is high because the company's stock price has fallen dramatically due to troubles with the underlying business. It's possible for companies in those situations to rebound and recover fully without ever having to make any changes to their dividend policies. However, what often happens is that a company has to reduce or even entirely eliminate its dividend in order to preserve capital for its own business needs. When that occurs, it often deals a double blow to income investors: Not only does the shareholder get less income, but the share price typically takes a hit as well.

One way to detect these so-called dividend yield traps is to look at the underlying fundamental business of the company to see whether it has the capacity to support future dividend payments. One simple thing you can do is to compare the total dividends the company pays annually with the company's earnings. If a company earns a lot more than it pays out in dividends, then that puts the company in a better position not only to sustain its past dividend payments but also to boost them in the future. Conversely, if a company pays out more than it earns in dividends, it can be a sign that the size of the current dividend payment is unsustainable, as it suggests that the company might have to borrow money in order to keep paying dividends at their present level. Investors will often refer to the payout ratio, which is the annual dividend rate divided by annual earnings per share, expressed as a percentage. Payout ratios above 100% indicate that a company is paying more in dividends than it's earning, while payout ratios below 100% show a surplus of earnings.

Payout ratios aren't a perfect metric for detecting yield traps, though, because earnings aren't always the best indicator of a company's health. In particular, some of the special types of businesses that are well-known for making monthly dividend payments -- such as real estate investment trusts (REITs), royalty trusts, and business development companies (BDCs) -- have special accounting rules that can distort reported earnings dramatically. For these industries, alternative measures of dividend sustainability can more accurately reflect likely future dividend-related actions. These alternatives include using free cash flow or funds from operations. Free cash flow, which measures the amount of cash a company's operating business generates and then subtracts out money spent on major capital projects, can give a clearer picture of what's happening with the company's actual working cash balance, especially in businesses that have a lot of noncash accounting adjustments that make official earnings misleading. Similarly, funds from operations takes out the adjustments made for depreciation of property and gains and losses on property sales, making it especially useful for real-estate-rich businesses that do many transactions involving property that can distort operating performance.

Also, bear in mind that some companies are required to have certain payout ratios in order to comply with various rules and regulations. For instance, REITs and BDCs get special tax treatment, but in order to get it, they have to pay out 90% of their earnings as dividends. That high of a payout ratio for a regular company might raise doubts about dividend sustainability, as even most mature companies tend to keep payout ratios below the 75% to 80% range in order to give themselves some flexibility for deploying capital back into their businesses. For dividend stocks that have significant growth potential, even lower payout ratios are ideal in order to provide ample capital to take advantage of strategic opportunities as they arise.

Top monthly dividend stocks worth a closer look

With all that as foreground, below are five of the most promising top monthly dividend stocks for investors to consider.

Stock

Current Dividend Yield

Earnings Payout Ratio

AGNC Investment (NASDAQ:AGNC)

11.4%

75%

LTC Properties (NYSE:LTC)

6.5%

104%

Pembina Pipeline (NYSE:PBA)

5.3%

109%

Realty Income (NYSE:O)

5.2%

231%

Shaw Communications (NYSE:SJR)

4.5%

94%

Data source: Yahoo! Finance.

These stocks have different focus areas, but they all offer healthy dividend yields and good track records of making monthly payouts to their shareholders.

AGNC Investment

AGNC Investment is the highest-yielding monthly dividend stock on this list, and that's for a very good reason: It's one of the highest-risk plays as well. AGNC is a real estate investment trust that invests in mortgage-backed securities rather than holding actual real estate, essentially betting that the returns it can earn on its investments will exceed its cost of capital, or how much it has to pay either to banks or other lenders to borrow money or to equity investors for them to be willing to invest in its stock.

The best environment for AGNC is one in which short-term interest rates are low and moving lower. Such an environment allows the mortgage REIT to borrow extensively with short-term financing, using the money it obtains to build up a larger portfolio of longer-maturity mortgage-backed securities. When yields on long-term bonds are substantially greater than the rates on short-term borrowing, AGNC is able to make a substantial profit. Those favorable conditions have prevailed for much of the past decade, and AGNC's total returns -- considering both dividends and share-price movements -- have been good.

The challenge that AGNC now faces is that those conditions appear to be changing. The Federal Reserve has started to boost short-term rates, and the spread between mortgage-backed security yields and financing costs has narrowed significantly. Partially in anticipation of those moves, AGNC has shifted its investing strategy, and that's required the mortgage REIT to reduce its dividend twice since switching to a monthly dividend distribution in 2014. So far, though, AGNC's share price has held up well compared to its peers, and despite the risks, many dividend investors are comfortable with the combination of high yield and long-term growth prospects.

LTC Properties

LTC Properties is also a REIT, but it owns actual properties rather than securities. The initials in the REIT's name provide a hint about its focus area, as it invests in senior housing developments and projects, as well as healthcare-related properties that aim to meet the long-term care demand for the aging U.S. population. LTC's portfolio of more than 200 facilities includes properties that specialize in assisted living, memory care, range-of-care, and post-acute skilled nursing services. The properties that LTC owns and operates through joint ventures, sale-and-leaseback transactions, mortgage financing, preferred equity, and mezzanine lending arrangements span the nation, covering the West Coast, the Southwest, and most of the heartland and the Deep South. Typically, LTC arranges to have partners operate its facilities. The REIT hopes to continue expanding its geographical reach in an effort to take maximum advantage of opportunities in every region of the country.

Unlike AGNC, LTC Properties has a long history of monthly payments that dates back to 2005. Over that span, the REIT has increased its monthly dividend on nine occasions, producing a more than 70% overall increase in what shareholders receive every month over that 13-year time span.

LTC's addressable audience is poised to grow still further. Over the next 45 years or so, the population of senior citizens is expected to double, and number of people over 85 years old will see a threefold increase by 2050. Given that the older segment of retired seniors is the most likely to need the long-term care that LTC's facilities provide, this demographic shift could have dramatic growth implications for the REIT over the long haul -- and for its payout to shareholders.

Pembina Pipeline

Unlike the first two stocks mentioned above, Pembina Pipeline isn't a real estate investment trust. Pembina is a leading pipeline operator and provider of midstream energy infrastructure services, which include things like oil and natural gas pipelines, storage tanks and terminals to facilitate shipment of energy products by land or sea, and wholesale marketing of energy products to downstream businesses like gas stations. It's based in Canada, and the level of activity in the energy industry there has given Pembina plenty of projects to work on in recent years.

Like many midstream energy providers, Pembina hasn't gotten through the past few years of weak oil prices without seeing some pressure on its core business. That showed up not only in its business results but also in its dividend payouts, which fell as crude prices dropped from triple-digit levels to as low as $30 per barrel before rebounding.

The company didn't shy away from investing in opportunities for growth even when markets hadn't yet established themselves on a path back toward sustained price gains, taking on nearly 3 billion Canadian dollars' worth ($2.26 billion) of oil and gas infrastructure projects located mostly in the western Canadian provinces of Alberta and British Columbia. An even bigger strategic move came from Pembina's CA$9.7 billion purchase of midstream peer Veresen announced in May 2017, which combined their portfolios to make the combined company rich in pipeline, terminal, storage, gas processing, and fractionation facility assets.

Now, things are starting to go a lot better for Pembina. The company is working hard to get liquefied natural gas from rich inland gas fields to terminals on the West Coast of the U.S. and Canada, including the Jordan Cove project in Oregon that Pembina is working on. Even as it cuts back slightly on capital spending, Pembina has the potential to reap big rewards from rising energy prices, and that could spur more customers to use its energy infrastructure assets and help support growth for its already solid 5.3% dividend yield.

Realty Income

There's no company that embodies the monthly dividend concept better than Realty Income. The real estate investment trust has even trademarked its claim as The Monthly Dividend Company, and shareholders have reaped the rewards for decades. Realty Income has paid 574 consecutive monthly dividends, and for 82 quarters in a row -- more than 20 years -- the REIT has boosted those monthly payments. With a total return averaging almost 16% annually and dividend growth running at nearly a 5% annual rate, Realty Income is walking the walk when it comes to providing reliable monthly income to its shareholders.

Realty Income comes up with its dividend distributions by having a highly diversified portfolio of real estate holdings. The REIT has more than 5,300 properties under long-term net lease agreements, which puts the burden on tenants to pay for certain expenses such as property maintenance, insurance coverage, and real estate taxes and therefore leads to a more reliable and predictable stream of net income for Realty Income. Those properties cover all but one state out of the 50. Realty Income has found more than 250 commercial tenants to lease its properties. Although the REIT does have a decidedly retail focus, the company boasts tenants in almost four dozen different industries.

Some investors have worried that Realty Income's retail exposure puts it at risk. With a trend away from mall-based traffic toward e-commerce shopping, the concern is that the tenants that lease space at Realty Income-owned properties will eventually go out of business or move their operations online. Yet Realty Income fights against that risk by concentrating on those portions of the retail industry that are less vulnerable to adverse trends. For instance, many of its tenants are drugstores and other providers of necessary goods and services. Realty Income also counts fitness centers and movie theaters among its key tenants, taking advantage of a shift toward greater provision of services at commercial property locations. Focusing on retailers that offer low prices to their customers also helps to reduce disruptive risks from online competition. With such a long history of success, Realty Income has the experience and know-how to navigate changing trends and find ways to produce the monthly dividend income its shareholders count on.

Shaw Communications

The telecommunications industry has historically been a good one for dividend payers, and Shaw Communications is no exception. As a leading player in the Canadian telecom market, Shaw serves nearly 7 million consumers and enterprise customers with the broadband, voice, and video services that they need. Shaw's monthly dividends work out to a yield of 4.5% currently.

Shaw faces many of the same pressures that its peers in the industry have had to deal with lately. Customers north of the U.S. border are also cutting the cord, and Shaw has seen trends toward falling numbers of subscribers for traditional landline and cable television services. So far, Shaw has done a good job of encouraging customers to boost their broadband service in order to offset the losses on the voice and video side of the business, but some investors still worry about Shaw's future.

Nevertheless, Shaw knows what it needs to do in order to stay ahead of the competition. The telecom giant announced recently that its first 5G technical trials in the Calgary market had gone well, showing that the pace of technological advances is just as important in the Canadian telecom industry as it is for its U.S. counterparts. As with the other Canadian companies on this list, Shaw shareholders who are U.S. residents have to pay attention to the relative values of the Canadian and U.S. dollars in considering what their dividend income will look like. Yet with a long history of solid performance, Shaw has the chops to find new ways to grow in a fast-moving business.

When you think dividends, think monthly

Not all investors need regular income, but if you do, monthly dividend stocks are some of the best investments you can find. By matching up the timing of when you get portfolio income with when you need to spend it on your living expenses, you can be more secure that you'll be able to meet your financial needs from your investments.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.