How I Make a Passive Income with Stock Dividends

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If you haven’t been checking the stock markets lately, let me just tell you that they stink. My own stock portfolio is down about 20% since the beginning of the Recession/Euro crisis. The only reason I’m not crying right now (or just cashing out my equities and hitching a ride to Vegas) is because of my dividends. On average, I collect 13% from my investments through dividends alone, a sum that not only helps pay my bills but also mitigates the market losses that I’ve sustained.

Quite a few companies pay monthly, quarterly or yearly dividends to their shareholders. S&P senior analyst Howard Silverblatt reported that for 2012, a record $279 billion will be paid out in dividends via 401 companies on the S&P 500. Meanwhile, companies that already pay dividends are raising their distributed amounts; for example, Sturm Ruger (NYSE: RGR) recently increased its quarterly dividend by over 50%. The pressure to dole out and/or increase dividends is immense as companies strive to attract spooked investors back into the fold (and to their stock).

There are two major advantages to owning dividend-bearing stocks. The first is, of course, collecting the dividend itself on a monthly or quarterly basis. The second advantage is from dividend reinvestment. Many companies offer dividend reinvestment programs, or DRIPs, which automatically use dividend payouts to purchase additional shares of company stock. Over time, such reinvestment leads to greater stock ownership and a bigger dividend. So, you can take your dividends and spend them now or “save” them in the form of additional company shares.

Cheap Ways to Get Your Dividend Feet Wet

Before you can even think of collecting dividends, you’ll need a brokerage account for buying and selling equities (i.e., stocks). Sure, there are the big-name brokerage houses like Edward Jones or Merrill Lynch where a single trade runs you a couple hundred dollars. Even discount sites like Charles Schwab require that you invest a $1,000 minimum amount and place trades at an $8.95 commission. What happens if you only have $50 to invest and can’t squirrel away a minimum amount of $1,000 or even $10? Here are a number of “bare-bones” brokerages that won’t charge you a lot of money to start buying dividend-bearing (or any other) stocks:

ChoiceTrade – With this broker, you can conduct direct access trades for just $1.50. The site charges a commission of $0.0025 per share with $1.50 being the minimum commission. Thus, you can buy up to 600 shares of stock for a very low price. If you regularly buy “blocks” of shares every month or week, this is the site for you.

ShareBuilder – Back when I had two nickels to rub together for stocks, I carried an account with ShareBuilder. For just $4/trade and no minimum amount required, I held my head high as I talked about my trading portfolio that contains roughly 1.5 shares of Eli Lilly, 3.6 shares of Penn West Trust, and 9.7 shares of Ford.

TradeKing – A flat fee of $4.95 allows you to trade stocks and build your dividend-bearing portfolio. The site also offers a number of valuable research and tracking tools.

Zecco – This site also charges a flat trading fee of $4.95. It offers access to the ZeccoShare Community, where the portfolios of star investors can be tracked, studied and even questioned.

How the Dividend Cycle Works

If you’re not sure what companies mean when they talk about ex-dividend dates, record dates, etc., here is a quick lesson on how the dividend cycle works.

Dividends are usually declared by publicly traded companies on their company website and/or through investor newspapers like Investor’s Business Daily. At this Declaration or Announcement Date, the dividend amount is noted as well as the stock’s Ex-Dividend Date and Record Date. This information is pertinent to those investors who are counting on receiving a stock dividend even if they do not yet own that stock.

The dividend is typically derived from the revenues of a company and is deposited directly into stockholder brokerage accounts (or sent via check). To obtain the dividend, you must be a stockholder with the company by its ex-dividend date, which is the date on which the company stock starts trading “except for the dividend”. Thus, if you purchase a company stock on its ex-dividend day or after, you are no longer entitled to its upcoming dividend.

Usually two trading days after the ex-dividend date there is a record date, which is the date on which the company accountants record all stockholders on record. Because securities transactions take three trading days to “settle”, meaning that they are now recognized as valid by the Securities and Exchange Commission (SEC), you must already own your shares three days before the actual record date. In other words, you need to buy your stock shares at least one day before the ex-dividend day in order to receive that dividend.

Going back to Sturm Ruger, the company recently declared a dividend of 32.4 cents/share with an ex-dividend date of May 10th, a record date of May 14th (because of the weekend), and a dividend payable date of May 29th. This means that you would need to purchase RGR stock on May 9th or earlier to receive its dividend 20 days later.

Should You Go Dividend Poaching?

Many investors, including yours truly, rely on dividends as a second source of income. Knowing how a company’s dividend cycle works begs the question of whether you should “poach” dividend-bearing company stocks simply to collect their dividends. In essence, you could make some quick money by buying a company’s stock the day before the ex-dividend date and then selling that stock a few days later. After the sale, you could use your freed up cash to poach another dividend-bearing stock, and so on. In theory, using such a technique could set you up with a dividend payout for every day of the month.

There is a problem with this approach, however. Once a company undergoes an ex-dividend date, its stock often depreciates in value. This is to be expected because the company is now trading without a significant portion of its cash. Typically, company stock depreciates the same amount of money as its dividend payout; if a company pays a dividend of 20 cents per share and its ex-dividend date is on August 1st, you can bet that the company stock will also be trading 20 cents lower on August 1st. Still, many investors go dividend poaching in the hopes that a company stock will soon return to its pre-ex-dividend date price and be sold at no capital loss. Back in the booming 90’s when the markets grew like mad, investors could easily poach a dividend and sell the stock at gain, making money twice. Today, however, that’s not the case.

My Dividend Investment Approach

Personal disclaimer here: I’m not a market analyst or investment professional of any type. I merely like to invest in company stocks and make a passive income through my investments. With that out of the way, here is how I make a 13% annual dividend-driven return on my stock investments:

I invest in REITs.

Real Estate Investment Trusts are a special brand of business that pay out at least 90% of their profits to shareholders in return for a special tax-exempt status from the IRS. REITs typically make their money from income-generating commercial real estate but they may also purchase loans that are backed by real estate collateral. Given the government’s currently low interest rates, REITs are making a good profit by borrowing money and lending it out in the form of mortgages or rental property.

As a whole, REITs pay anywhere from 1 to 21% annually in dividends. While it’s tempting to go after the stocks that pay the highest dividends (Origen Financial currently pays 21.43%), you should carefully research the company first- just as you would any company you’re about to hand your money over to. For a rather complete list of REITs and their dividend payout rates, check the following REIT listing from DividendYieldHunter.

I invest in “Dividend Aristocrats”.

Some companies habitually increase their dividends over time, which is a good sign of their stability and corporate health. AT&T is one of these companies, having increased its dividend each year for the last 25 years. AT&T’s current annual dividend payout is 5.17%. Kimberly-Clark, Family Dollar and Ecolab are other examples of so-called “Dividend Aristocrats”- large, blue chip companies that have steadily increased their dividend payouts for the past 25 years. By investing in such companies, I increase my odds of holding onto a stock that will not only pay me money, but will also pay me even more money over time (through the miracles of increased and compounded dividends).

I get down and dirty with statements.

Companies are obligated under SEC rules to submit quarterly (10-Q) and yearly (10-K) financial reports. These reports are listed on the company website, usually in its investor section. Your brokerage will also hold copies of financial statements (usually under the company’s stock ticker).

I make sure to track down these statements and look over them before buying or selling any company’s stock. Generally, they include the operations statement, balance sheet, the income statement and the cash flow statement. If I can’t figure out how a company is making its money or why its debt is increasing (or decreasing), I let it go and look for a company I can understand. Likewise, if I see that a company I hold is going further and further into debt or is making questionable decisions, I sell it fast. Collecting high dividends is great and all, but the company also needs to be solid and not a fly-by-night (i.e., bankrupt) operation.

The Bottom Line

Dividend-bearing stock is just one way you can make a passive income from your investments. However, it is also one of the easiest investments you can make and benefit from. You can use dividends to pay your bills now or save that cash for additional dividend-bearing stock.

Either way, owning such stock sure beats holding your money in a bank account that pays 0.5% interest or in Treasury bills that are now producing a laughable 0.18% interest (for a 52 week bill). Of course, investing in stocks always implies taking on the risk that a company stock could depreciate over time or that the company itself could fold. This is why I (again) stress that you carefully research any company you intend to invest in.

Personal disclosure: I own shares of Sturm Ruger (RGR) and Ford (F).

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5 Comments

  1. I will check out the Investors Business Daily and Motley Fool too! Thank you once again..As I said previously I need all the help and guidance I can get :-)

  2. Thanks Cheri! It’s always encouraging to receive positive feedback from a reader. When I was first starting out with stock investments, I read Investors’ Business Daily to better analyze stocks. However, those “for Dummies” and “Idiot’s” books are a great help too. And don’t forget the Motley Fool!

  3. Thank you for sharing this information! I am quite interested in learning about making a “passive” income on the side..I am definitely going to check out these websites that you have listed! Also perhaps some of the “Stocks for Dummies” “…for Idiots”” books too..As I need all the help I can get! LOL Again, great article!

  4. Hey Alex, thanks for your comment. I’ve been investing for over a decade now and sites like ShareBuilder, ETrade, etc. make it really easy. Please let me know if you have any questions.

  5. Thanks for sharing this great advice on getting started making passive income with stocks. I’ve always been pretty terrified of stocks, but this makes it sound like a pretty good option I should look into. Passive income is certainly my favorite kind of income!