Updated on 09.15.14

Earning Regular Income from Stock Investing via Dividends

Trent Hamm

A few days ago, I had the opportunity to sit down with a fellow in his early sixties who has already retired. He had been self-employed his entire life. I told him about The Simple Dollar and I asked him, if he didn’t mind, if he would tell me about how he had invested for retirement.

What he told me boiled down to four principles.

I spend way less than I earn. By this, he meant he had enough saved up at age fifty to walk away from his work, but he kept at it for several more years so that he could build up even more savings. He wanted the investments to return substantially more each year than he would spend.

I keep a years’ worth of living expenses in cash and CDs. This isn’t just an emergency fund, but it helps him do okay through the ups and downs of his other investments. If they don’t return as well as he’d like for a quarter or two, things aren’t disastrous – he still has a lot of breathing room.

I roll the excess back into my investments. Whenever he starts to build up way more than a year’s worth of savings, he rolls it into more investments. He keeps pretty careful track of his spending and thus has a strong estimate of the year to come. If the amount in cash and CDs gets over fifteen months worth of living expenses or so, he cuts it down to twelve months worth and puts that difference into his investments. And what are they?

All of the rest of my money is in stocks which pay a good dividend. All he does is buy stocks in companies he believes in over the long haul that pays good dividends. He rattled off quite a number of income stocks, but the four I remembered were GE, AT&T, Verizon, and Bank of America.

So how does that work? Let’s take a look at AT&T (Google Finance). As I write this, a share of AT&T is at 24.83 and has a dividend of 0.40. What that means is that every three months, for each share of AT&T that a person holds, AT&T pays that person $0.40.

So, let’s say that over time, our friend has bought 1,000 shares of AT&T – at today’s market prices, that would have cost him just short of $25,000. This means that every three months this year, AT&T is directly going to pay him $400. Over the course of a year, that would have added up to $1,600. And if that dividend holds, over ten years, the investment would pay out $16,000.

Obviously, the board of directors of a company can choose to raise or lower a company’s dividends – here’s a recent history of AT&T dividends. That’s why our friend chooses to buy only stable companies that have a long history of paying good dividends.

What about the stock price? Aren’t stocks tanking? For the most part, our friend doesn’t care about the stock price. All he cares about is the dividend – as long as it stays reasonable, it doesn’t matter to him how much or how little the stock can sell for. He intends to hold it for a very, very long time.

In fact, he’s actually ecstatic about the low prices on many income stocks. He’s about to buy more of his dividend-earning stocks and given the low market, he can get more shares for his dollar right now.

Is this a good investing strategy for me? Provided that you’re willing to have a diverse selection of dividend-paying stocks (more than 10 with no more than 20% of your money in any individual company or any sector) and you’re willing to pay attention to it so you don’t end up holding a company as it falls down the Enron drain, this strategy can work. It’s often discussed in investing books as “dividend investing” and can work very well for you, not only as a retirement plan, but as a way to build steady income.

Do you want to know more? My friend strongly recommended that I read The Ultimate Dividend Playbook, a book produced by Morningstar that covers dividend investing in detail. I can certainly say I’m intrigued, and I’ve added the book to my to-be-read pile.

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  1. Interesting article. So few people think about or talk about dividend earnings, it seems to me, when discussing stocks.

  2. Buk says:

    I like stocks that have a high dividend yeild(dividend/price) but the reality of the story is that the gentleman you talked with would have just as healthy a retirement if he had invested in an index fund or growth stocks versus high dividend stocks. He was responsible with his money and that is the real lesson – investing enough each year to fund a healthy retirement. I bet if you compare his stock yeild(including dividends) to the S&P they would be similar over the last 20 years. He jsut gets paid out quarterly rather than having to sell shares of his growth stocks or indux funds. Keeping a year of savings handy in cash is a good idea though to buffer market ups and downs when drawing from an investment account. If you were in stocks, you could be using cash reserve now versus moving out of a down market. Of course if you are into retirement, hopefully not too much of you money is tied to such risky investments.

  3. Battra92 says:

    The thing about dividend earnings is, well I’m 26 so they don’t seem to make sense to me now. Maybe when I get close to retirement (40 sounds good) I will have to look into that.

  4. Aya @ thrive says:

    Although the plan seems to work for him but this seems to only apply to a very small population, considering that not many people are even at the stage to be saving and investing as heavily. The spending less than one earns is a rule that many people probably hope to follow, but it is difficult to abide by simply because not all of us make that much money in the first place. It doesn’t hurt to make it a long term goal though.

  5. Added bonus: Dividends are taxed at a lower rate than other interest income.

    @Battra92: Don’t discount the power of a dividend reinvestment plan. Owning stocks (or mutual funds that own them) and having the dividends automatically reinvested is essentially a way to double up on your dollar-cost averaging.

  6. Trent – interesting post. I’ve always just reinvested dividends and never gave them a second thought. I’ll have to pick up a copy of the book; thanks!

  7. Trent,
    Your friend is taking advantage of the best investing strategy for providing growing income in retirement.
    Minus the curretn dividend cut from Bank of America (which will come back in the next 2-4 years IMHO), those stocks provide your friend with a retirement income stream that grows at a faster rate than inflation – meaning he is getting exponentially wealthier (via cashflow) each year by doing absolutely nothing!
    I am not yet 30, but this is the strategy that I am following and it is already providing me with a growing income stream – although not quite enough to retire on just yet!
    Great article Trent!

  8. To further illustrate my point, be sure to look at the history of the dividend for AT&T. You will notice that the dividend payment has gone from $0.27/quarter in 2003 to the current $0.40/quarter in 2008.

  9. No Debt Plan says:

    Why wouldn’t he just buy bonds?

    How does he plan to keep up with inflation? Sounds like the plan is working for him, but I’m curious.

  10. sometimes nothin is a real cool hand says:

    1) Bonds do not appreciate in value in the same way that stock does.
    2) Dividends are typically taxed @ only 15%
    3) There are many companies that have increased their dividend EVERY YEAR for over the last 25 years (think about that, that includes three bad stock markets)
    4) If you look carefully, there are some amazingly good deals out there on dividend stocks. I wont name names, but it is pretty easy to lock in 10% dividends with SIGNIFICANT possibility of stock appreciation. There are some scenarios that are even a lot better than that. Your mileage may vary….

  11. George says:

    @No Debt Plan:

    Bonds don’t increase their payout if the business grows. For instance, Pepsi had a dividend in 2003 of 16 cents per share and they have steadily increased it to 42.5 cents per share today.

    As for keeping up with inflation, good companies grow their dividends far faster than inflation (again, look at my example with Pepsi). Has the value of your dollar decreased to 37 cents in 5 years? Yet here we have a company that’s nearly tripled their dividend in the same period.

    By the way, don’t look at just stocks with dividends. You can also find similar effects in REITs (Real Estate Invest Trusts) and MLPs (Master Limited Partnerships). REITs and MLPs also have tax advantages that can be helpful, provided you’re willing to deal with the paperwork (but, except for small amounts, these two do not belong in IRAs/Roths — get some tax advice before doing so).

  12. Mike says:

    Trent, excellent article and an aspect I’ve thought little about. In fact, I only hold a couple of stocks that even pay dividends and that wasn’t even a rationale for their purchase.

    Is there a fund built up of dividend paying stocks? Something similar to a mutual fund or lifecycle fund that is based on dividend paying stocks?

  13. Chad says:

    @Battra92 : most strategies when they talk about the stock market investing and receiving 8 to 10 percent annually are reinvesting the dividends so you might as well pick a stock with a dividend over one that doesn’t have one.

    Trent: when you read that book I would very much like to see it as a Sunday review.

  14. Nick says:

    If you’re in it for the long term, dividends are great. You can’t argue with real cash in your pocket.

  15. Heather says:

    With Treasury insisting that the big banks take part of the TARP plan or “bailout” (so that the weak banks are not specifically identified, which could lead to a run), these banks might, if I understand it correctly, have to stop paying dividends.

    Of course smaller banks will also be participating in TARP. And then there’s GM, etc. which will also be receiving bailout money. So I’m guessing dividends will take a huge hit moving forward.

  16. Chris says:

    The US Treasury also offering Treasury Inflation-Protected Securities (TIPS) as a hedge against inflation.

  17. Eric Twitty says:

    Great post as usual Trent. I just recently started reading your blog and I’m very impressed with the quality of your posts. I agree with Tyler, dividends can be a great income stream in retirement.

  18. Roger says:

    Pretty nice; it sounds like your friend has things in the bag, monetarily speaking. The more I read and learn about dividend investing, the more appropriate it seems for me, at least as part of my overall strategy. I’ll have to give that Morningstar book a look, if possible.

    It might be worth noting that there are index funds that track dividend paying stocks. Vanguard offers two of them, the High Dividend Appreciation Index (VDAIX), which tracks stocks that regularly increase their dividends, and the High Dividend Yield Index (VHDYX), which tracks stocks that pay a high dividend. Both yield a nice sized dividend; VDAIX has a yield of $0.10 per share, ($21 per year per $1000 invested, at current prices), while VHDYX yields $0.14 per share ($33 per year per $1000 invested at this writing). While that’s not as much as some individual high-yielding stocks, since they’re mutual funds and hold hundreds of stocks, the chance that an Enron-style failure could take out 5-10% of your portfolio is virtually non-existant. Just something to consider for anyone looking for other ways to invest for dividends.

  19. KC says:

    Since stocks are “tanking” it makes dividend investing even better. Take a company like McDonalds. It pays a hefty little dividend and is a very strong company. But since the price is way down its dividend is higher (according to the price you pay per share). So by stocks “tanking” you get a better dividend return. This is a great time to buy dividend stocks.

  20. That’s the beauty of dividend investing: you will get some money from them regardless of the up and down movement of the security. And you may get some extra if it goes up. If it goes down, the yield will be higher (unless they cut the dividend). It def. has a place in every responsible investor’s portfolio.

  21. Donny Gamble says:

    Dividends are probably your safest bet in this kind of stock market. With all the current market volatility it is best to invest in stocks that carry a nice dividend.

  22. Great article. Dividends are a wonderful way to protect yourself from losses when the company is fundamentally sound. Unfortunately over the last few years companies aggressively grew those dividends beyond their fundamentals means.

    The best of the best remain and those are where investors should be focusing.

    Great site btw.

  23. These days if I buy stocks, I only buy Canadian stocks paying good dividends. Stock price fluctuates but dividend payments generate steady income, and keep me going through good and bad times.
    A Dawn Journal

  24. Izabela says:

    Trent, also remember that for this type of investing you can use DRIPS (most of dividend paying companies have these programs), and pay minimal costs for acquiring new shares!

  25. JonFrance says:

    One thing people should watch out for is a lot of the lists of great “dividend stocks” include a lot of financials, which historically have paid great dividends. However, one of the conditions of the bailout is that the government is going to start requiring a lot of these companies to cut or stop paying their dividend, so don’t expect financials to pay as well as they historically have.

  26. I have been big on dividend paying stocks for some time, and (like George above) I think that there are other investment vehicles which should not be overlooked. REITs play a good part in the portfolio.

    Since bonds were brought up, should we not consider the traditional 70/30 split between stocks and bonds. Yes bonds do not pay as well, but they help play a part in averting risk during times when stocks face difficulties (a good bridge to weather financial storms is my point). I am surprised that people are not buying certain stocks at this time (like the AT&T mentioned in the post). With such good values to be had, it would seem a good time for the small investor.

  27. Brandon says:

    The best thing about dividend paying stocks is that unlike stock price appreciation, the gain is realized immediately in real money rather than money that only exists on paper. The downside of course is that you do not get the better capital gains tax rate.

  28. Another thing to note is that dividends are paid with after tax dollars by the corporation which means a tax break for dividends received by the investor. That’s what I base my whole leveraged investing strategy on, buying strong dividend paying companies that increase their dividends on a regular basis.

  29. Frugal Dad says:

    This is an interesting concept. Combined with savings in high-yield cash-based vehicles, Treasuries, etc, I could see living off dividends a very real possibility.

  30. Dividend Growth Investing is a nice strategy where you build a diversified portfolio of stocks that have a long history of consistently increasing their dividends for over 10 to over 25 years. The dividend growth from most such companies has been higher than inflation over the past couple of decades.

    Furthermore, stocks that increase their dividends regularly have outpeformed stocks that don’t increase their dividends or even worse cut or eliminate them.

    The Dividend Aristocrats list is pretty much a very good starting point to research.


  31. Kevin says:

    I have a couple clients that hold dividend paying stocks and they do quite well living off that income.

    Contrary to what Brandon says – they only pay 15% income tax (same as long-term capital gains) on that money. It’s a great way to earn a living if you can do it.

  32. No Debt Plan says:

    @Kevin: Wouldn’t this (the 15% rate) only be true as long as the Bush tax cuts hold? Or am I thinking of something else?

  33. Beauregard Picklefeather says:

    What do y’all think of dividend reinvesting, whereby instead of taking a dividend payment every quarter, that money is automatically invested in additional shares. It’s like quarterly dollar cost averaging.

  34. I have previously been a huge of dividend stocks, however with the credit crisis and volatility of the market I fear companies will plow profits back into the business to increase their market share, rather than extend dividend payments to shareholders.

    With the market so hammered, I have been buying leveraged ETF’s that are selling at such low prices. I think there are great buys in all of this hysteria.

    Of course, what fits for me may not look good at all to others.

  35. Jim says:

    I’ve been more interested in buying high dividend stocks right now. I’m looking at both high yield large caps like AT&T, GE, Verizon, CAT, Cocacola, etc and also high yield REITS. There are some good REITS with sound financials paying very high yields right now. HRPT Properties (HRP) is yielding over 28% at the moment. Downside with REITs is that the earnings and dividend rates aren’t quite as dependable as a solid Dow stock.

    @George, you said: “REITs and MLPs also have tax advantages that can be helpful, provided you’re willing to deal with the paperwork”. What are those tax advantages??


  36. Nate says:

    I’m definitely going to have to pick up this book from the library. I’ve been looking into buying Stocks for some time. I already own one piece of Real Estate, maybe it’s time to get into the stock market as well.


  37. Kevin says:

    @No Debt Plan – the 15% long-term capital gains rate applies to dividends from domestic corporations through 2010. So we have that rate for this year and 2 more after.

    Actually, if you’re in the normal 10% or 15% bracket, you pay 0% on these dividends!

    @Jim – some REIT dividends are “qualified” which means they are taxed at the lower capital gains rate, but in my experience, most are taxed as “unqualified” dividends. LP’s have some tax loopholes, I guess, but the paperwork is daunting if you don’t hire a pro, and most of the time the losses are limited anyway since they are classified as “passive activities”.

  38. Oliver says:

    There is the downside that you have to pay more taxes on dividends earlier than if the company was to reinvest all the earnings (due to the time value effect).
    Also, the beneficiaries wont have to pay any capital gains tax at all if you pass away.
    It is good to have stocks that pay dividends as part of a diversified portfolio, but I wouldn’t base it on dividend paying stock.

  39. Cindy says:

    This sounds great but if you only have enough income to get check to check how do you accumulate anything. Also if there is an emergency which seems to always come up when you get ahead there is never any extra. What do you do?

  40. Sharon says:

    When you are young you can DRIP, which is where the dividends are reinvested in buying more of the stock, which avoids any fees to purchase the stock. Then later you can switch to receiving the divident.

  41. George says:

    @Cindy – you ask for a raise, look for a better paying job, and reduce expenses. Buy a few shares in a DRIP and let it grow.

  42. George says:

    @JIM – MLP distributions (aka dividends), for the first 10 years or so, do a “return of capital” that’s prorated and reduces the basis of the units (aka shares). Thus you only pay taxes on the amount of the distribution that’s above the prorated “return of capital”.

    The paperwork is confusing if you make lots of trades while also collecting distributions, but, if you buy-and-hold, then the MLP has already done the legwork and it’s no worse than filing an extra tax form with your 1040 long form that is as simple as the 1040EZ.

    MLP distributions, by law, need to be most of their profit (like 90%). At current market prices, most MLPs are yielding 8-12%. The ones I’m familiar with are APU, OKS, and AB (First two distribute energy and the third manages money).

  43. Sherilan says:

    Thanks Trent, I have this on reserve at the library. Any plan to review “The Little Book of Bull Moves in a Bear Market,” “The Little Book that Saves your Assets,” or “The Smartest 401K Book you will ever read?”

  44. Excellent post! I’ve actually been looking into the possibility of dividend investing for a while now, but I don’t really have any extra disposable income to dump into the market right now. Nevertheless, I was wondering if it is feasible to earn a regular stream of supplemental income from dividends over a long period of time, and this seems to have answered my question. Thanks!

  45. Ethan Bloch says:

    Great information. Thanks for sharing. This should be sent out in a national letter to all soon-to-be retiree’s ;p



  46. Understanding the basics of stock market investing is crucial before putting any of your money at risk. This is true whether you are going to pick your own stocks, put money in mutual funds or hire a financial adviser or stock broker to do it for you.

  47. Joe Wood says:

    Fantastic article. Another possibility I’ve never seen you expounded upon (sorry if I missed any articles) is residential real estate investment. The bubble has popped and interest rates are really low. Being a landlord can produce amazing regular cash flow, if you do it right.

    Joe Wood

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