In today's low interest rate environment, many retirees are looking at stock dividends as a potentially better source of income than bond interest. While the potential is certainly there, income seeking investors should be wary that their supposedly juicy payouts may turn into dividend traps that steal their much needed retirement capital.
Still, it may be possible to earn $1,000 or more in monthly retirement dividends. These six easy steps can help you along the path. Just be sure to recognize and balance the risks with the potential rewards so that you can maximize your chances of success.
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1. Decide if you really need the dividends monthly
A monthly $1,000 in dividends works out to $3,000 per quarter or $12,000 per year. Does it really matter to you how often that cash comes in, or are the total amount of income and the reliability of that income more important to you? Many very strong American companies pay their dividends quarterly, while others only pay out once or twice per year. It would be a shame to miss out on owning great businesses just because their dividends don't pay out on a schedule that's more convenient for you.
If your worry is that you'll spend the cash as soon as it comes in, one option is to let your dividends pile up as cash in your brokerage account. Then, set up monthly transfers from your brokerage account to your checking account for the $1,000 you expect to receive from your dividends on average. As long as you start with enough of a cash buffer and the dividends pay out as expected, you can get your $1,000 per month in cash flow from your dividends despite their payments arriving with lumpier timings.
2. Learn the calendar dates that matter
There are three dates that really matter for most dividends: the declaration date, the ex-dividend date, and the payment date. To the extent you care about the timing of your dividends, you should understand these dates and how they work together.
The declaration date is the day the company's board of directors announces how much the company's next dividend will be and when it will be paid. That date is important because dividends are not guaranteed payments, and until a dividend is declared, you can't be certain that the company will actually pay it.
The ex-dividend date is the first day the stock trades without the dividend. If you want to collect the dividend, you must own your shares at the end of the day just before the ex-dividend date. Typically, the stock's initial pricing on the ex-dividend date will reflect a decrease from the prior day, due to control of the dividend money moving from the company to its shareholders.
The payment date is the day your dividend gets credited to your brokerage account. That's important not only because that's the day you get access to your cash, but also because that's the day that typically matters for determining when any taxes may be due on that income. The payment date also matters if you're still trying to balance out your dividend payments by month, but hopefully that doesn't stay your primary concern.
3. Estimate how big a nest egg you'll need to get that kind of dividend income
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The Invesco High Yield Dividend Achievers Index ETF (PEY -0.94%) is a fund that owns higher yielding companies from a list of those that have regularly paid and increased their dividends. The fund provides a reasonable benchmark of companies with both decent yields and decent commitments to those yields. That combination makes it a decent proxy to estimate what you may be able to expect in terms of reasonably sustainable dividend income from your investments.
The fund's yield is currently around 4.3%, which means you'd need around $280,000 invested in it to get that $12,000 per year in annual dividend income, assuming its dividends are sustainable. Indeed, since the Invesco High Yield Dividend Achievers Index ETF pays its dividend monthly, you may be tempted to shortcut this process just by investing in it and being done.
While that might be tempting, 2020 was no ordinary year. That fund rebalances its holdings every March, which means it was wrapping up that work just as the COVID-19 shutdowns got serious. As it invests in companies that increase their dividends, chances are it may look different when it rebalances in March 2021. After all, many companies either suspended or stopped increasing their dividends due to the pandemic.
4. Look for signs of dividend sustainability
As Warren Buffett famously said, "you only find out who is swimming naked when the tide goes out." When it comes to dividends, 2020 proved just how much truth that saying holds. Around 10% of the S&P 500 companies announced decreases or suspensions of their dividends in the second quarter of the year, knocking out billions of income people may have been depending on.
The good news from that dividend disaster, however, is that many companies were able to maintain or even increase their dividends despite the economic slowdown put in place to fight the pandemic. Those that were able to do so might very well have the resilience to keep their payments intact for the long haul, but just looking at the dividend payment amount isn't enough to tell.
To improve your chances that the dividends of the companies you're interested in are really sustainable, look for how well those dividends are covered. Two key things you'll want to look at are the company's payout ratio and what portion of its operating cash flows are consumed by its dividend. The lower those ratios (as long as they're above zero), the better the dividend is covered.
In addition to that operational coverage, another key factor to consider is how strong the company's balance sheet is. The lower its debt-to-equity ratio (as long as it's above zero) and the higher its current ratio, the more likely its dividend can survive a short-term hiccup in its operations.
On top of those strict financial measures, make sure you have a reasonable understanding of how the company makes its money. With that understanding, look for ways its business can be disrupted and try to get a handle on how likely it is that disruption will happen in the near term.
These reviews can't guarantee your dividends will be sustained, but they can improve your chances of success. Given that you're dealing with dividends -- which are never guaranteed payments -- the best you can do is tilt the odds better in your favor.
5. Keep an eye on diversification
Because dividends are never guaranteed payments, you will want to spread your investments out across multiple companies in different industries. It's important to do so because individual companies stumble and entire industries can get disrupted. That way, challenges in any one of your investments will have much less of an effect than they would if that investment represented a huge portion of your portfolio.
Diversification can't improve your expected rate of return, nor can it keep you from picking an investment that goes sour, but it can reduce the impact a failed investment has on your overall finances. In seeking out diversification, be sure you're first finding good investments that meet your other criteria, such as a high likelihood of providing sustainable dividend income. That way, you can get the benefits of diversification while minimizing the risk of di-worsificiation.
6. Find and buy your stocks
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With the first five steps, you built a good game plan for how to get to your target goal of an average of $1,000 per month of dividend income. With this one, you actually look for and buy stocks that meet your criteria for investing.
There are several free stock screeners that you can use to help you find companies that look like they might meet your key criteria on dividend income, sustainability, and balance sheet strength. They will often also tell you the industry a company is a part of to help you get a head start on your diversification needs. You can use the screeners to get an idea of which companies to research further and then dig in deeper on the ones that seem promising to you.
Find the top 20 or so companies that meet all your criteria while still respecting diversification, and then buy their shares. You'll want to start with approximately equal dollar positions in each of them while buying enough shares so that your expected income reaches your $12,000 annual target. As mentioned in step three, with current market conditions and yields, that will likely require somewhere in the neighborhood of $280,000 -- maybe more or maybe less, depending on what you find.
Now go forth and manage your portfolio
The beauty of dividend-oriented investing is that when things go well for them, companies that are committed to their dividends will often raise those payments over time. The challenge is that companies and their dividends don't last forever. So once you've built your portfolio, keep an eye on the businesses within it. Plan to review each investment in depth at least once a year, and do a cursory overview with each expected dividend payment to get a sense of how well supported those dividends still are.
Prune the weeds, water the flowers, and keep an eye out for new businesses you may want to add to your portfolio or use to replace ones that no longer look like they're worth owning. With these six steps, you've got a great framework to give yourself a strong chance of keeping those dividends flowing into your pocket for a long time to come.
