Every Sunday, The Simple Dollar reviews a personal finance book or other book of interest.
I’ve always found the idea of investing in stocks for dividends to be an intriguing one. In a very simplistic way, that means you buy stocks in individual companies that are very stable and have paid strong dividends for a long time. Usually, you care little about the ups and downs of the value of the stock because your primary focus is in the dividend checks you receive as a stockholder.
Yes, The Little Book of Big Dividends is a new entry in the now quite long “Little Books” series from Wiley, each of which focuses intensely on a specific investing topic, writing about it in simple terms which everyone can understand. This entry is written by Charles B. Carlson, the editor of the DRIP Investor and long-time advocate of dividend investing.
Since I’ve had an interest in dividend investing for a long time, I looked forward to reading this book with a healthy dose of excitement. Does it live up to the potential or does it just stretch what I wrote in the first paragraph out for two hundred pages? Let’s dig in.
One | The Check Is in the Mail
The book opens with a clear explanation of what dividends are (small pieces of profits of a company given out to shareholders) as well as some common traits that companies that offer dividends have in common. Typically, they’re large, stable, and have a predicted future of stability. That, of course, means that they’re not growth companies (usually). It also discusses the most common way to compare dividends offered by a company, which is yield (annual dividends divided by the price of the stock).
Two | Super Size Me, without the Heartburn
Of course, investing is not without risk, and dividend investing is no different. Quite often, yield is a great proxy for risk – if you see a company with an enormous yield, there’s probably some serious risk involved. Healthy companies balance a dividend with investment in themselves, so if they’re dumping out tons of money to shareholders, there may be something fishy going on that’s not good for long term health. The best way to mitigate this risk is to avoid small companies paying any sort of exceptional dividend.
Three | If Einstein Was a Dividend Investor
In other words, a big part of dividend investing is looking at the total return potential, not just the dividend potantial. A company paying great dividends now that dies in three years is still a bad investment. How can you make sure that a given dividend-paying company is actually legitimate and worthwhile? The first place to look is in their financial numbers. Do they actually have a lot of money in the bank? Can they actually afford to pay out those dividends?
Four | The World Is Your Oyster
Here, Carlson makes the astute point that it’s worthwhile to look internationally for stocks that pay good dividends, because quite often the large companies in other nations are very steady dividend payers, just like those in the US. In fact, doing this can help diversify a portfolio of dividend-rich investments, making sure that you’re not too heavily invested in a certain sector.
Five | It Pays to Be Direct
Rather than investing through a broker, the best way to invest in a good dividend-paying stock is directly with the company. A few options are discussed here, but the most compelling one is known as a DRIP. Basically, it’s a program offered by some companies that allows people to buy stock directly from those companies with no fees. The dividends earned in those plans are directly reinvested into more stock in that company until you’re ready to sell it. It’s convenient, low cost, and very easy to manage.
Six | Postcards from the Hedge
One catch in all of this: if a company is paying exactly the same amount as their dividend for years and years, the investment gets worse. Why? Inflation. As years go by, a dollar is worth less and less, so if the same amount is paid out each year as a dividend, the company is actually continually reducing their dividend. Ideally, you want stocks that pay a dividend that keeps pace with inflation.
Seven | Lifeguard on Duty
Some people eventually reach a point where they live off of their dividends. If you plan to do this, keep a few things in mind. First, diversify. You don’t want to be completely left out in the dark if your company fails. Second, try to make sure that the dividend payment dates from the various investments you have are spread out, as it will make money management easier. Finally, avoid selling unless you have to, as selling reduces your dividend income level in future years.
Eight | Juice Your Portfolio without Striking Out
There are other options for investment that pay dividends besides stocks. MLPs are partnerships that invest in various assets. REITs are real estate trusts. These (and a few others) allow you to invest in things besides corporations and still earn dividends. These can be very useful in adding some diversity to your investment portfolio without sacrificing the steady income of dividends.
Nine | When DRIPs Become Floods
The neat thing about dividend reinvestment is that it can turn your dividend investing into a flood of money over time. Let’s say you buy some stock and agree to reinvest the dividends in more stock whenever it’s paid. You also agree to buy more stock regularly out of your pocket. It’s a good company, so the dividend payment goes up over time. Right there, you have three avenues for growth, and they can all build on each other.
Ten | If You Build It, Dividends Will Come
Just like any other investment, it’s well worth your while to develop a diversified portfolio when you’re buying dividend-bearing stocks. You should also buy bonds (which pay out regularly as well) as another component of your portfolio, and you certainly should diversify the stocks you own. The more stable it becomes, the longer it will support you safely and successfully.
Is The Little Book of Big Dividends Worth Reading?
If you’re unfamiliar with dividend investing, The Little Book of Big Dividends is really a good read. It’s tight, informative, and easy to understand.
Of course, on the other hand, if you know the basics of how dividends work and know what a DRIP is, you might not get too much out of this one. It doesn’t break any really new ground.
As for me, this book was very much worthwhile. It gave me the kick in the pants I needed to look into dividend investing. My wife and I are strongly considering trying out two different DRIPs and this book gave me the impetus to dig a little deeper.