How to Maximize Dividend Investment Returns

Fajasy
Updated: July 15, 2020

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Disclaimer

This article provides actionable steps on how dividend investors can maximize their dividend investment returns. Simply investing in great dividend-paying companies may be enough to bring you long-term financial security and cash flow. However, there are a number of measures and steps you can take to maximize dividend investment returns with little additional work and no added risk, as covered in this article.

Dollar-Cost Average Your Investments

Depending on how much your investing, you should either invest it all today or spread it out over a period of time.

As a dividend growth investor, you should be investing for dividends and cash flows. Therefore, the quicker you get your money into the market, the quicker you'll be able to receive and reinvest these dividends.

On the other hand, the market will always have its ups and downs, and if the market crashes tomorrow, this would not be good for you. Therefore, the best practice is to invest over a period of time, depending on how large your investment budget is. You would do this to eliminate market volatility risk and to essentially get the “average” of the market. This is also assuming that you can invest commission-free.

This is called dollar-cost averaging, and is an investment strategy that has been proven to work regardless of the current market behavior.

The table below provides an example of how long you could dollar cost average your investments, depending on how much you have invested:

Investment AmountDollar-Cost Averaging Months
$10001
$50003
$10,0004
$25,0005-6
$50,00010-12

Make Periodic Investments

As a long-term investor who is investing for dividends and income, you should make monthly periodic investments to take advantage of the double compounding effect in relation to dividend investing.

Aside from your initial investment, and regardless of the amount, you should always make monthly contributions to your dividend portfolio stocks (among other investments such as ETFs). You should also attempt to increase the amount you invest every month.

Moreover, it's crucial that you always have adequate cash balances to avoid tapping into your dividend portfolio in cases of emergencies. If you do, it will only hinder your future income potential.

With this in mind, if you’ve purchased at least $1000 or more in three or more dividend-paying companies, I would strategically invest my monthly contributions to maximize my returns.

What this means, is that after holding onto three or more dividend-paying stocks for at least a month and becoming comfortable with their price movements, I would determine which one has the best value out of the three. This would include factors such as whether it had gone down in stock price or whether it had a more attractive price-to-earnings (P/E) ratio than the other stocks.

You should always remember that the stock market is inefficient and that opportunities do arise!

With large blue-chip companies, what you’ll sometimes notice is that as the stock goes down in price, the dividend yield goes up. Therefore, as one buys during market lows, they will be locking in a better dividend yield! Of course, this is only a good thing if the fundamentals of the company have not deteriorated.

In short, if you purchase the right dividend-paying companies from the right industries, and attempt to manually invest your monthly contributions into the best value stock, you should (in theory) see greater returns on both your capital gains and dividends received.

Dividend Reinvestment

After you have decided how much you are willing to invest and in what dividend-paying companies, you should purchase these dividend stocks with a dividend reinvestment plan (DRIP) or an appropriate investment brokerage.

DRIPs themselves are extremely valuable for both small and large investors alike. A DRIP gives you the ability to purchase stock directly from a company through what is called a “transfer agent.” Most of these transfer agents have little to no fees, which is great for a smaller investor.

The other, and more common option, is to just use a brokerage with unlimited free-commission trades. You should use a brokerage that will automatically reinvest any of the dividends you receive back into the same stocks that payed out these dividends as "fractional shares." You can also manually reinvest these dividends if you desire as well.

Whether you choose to use DRIPs or an investment brokerage, the longer you continue to reinvest the dividends you receive from the dividend-paying stocks you own, the more cash flow you will be able to generate in the long-run. In other words, by reinvesting all of the dividends you receive, you'll be able to compound and grow your dividends at a much quicker rate.

The visual below illustrates why reinvesting all of the dividends you receive is so important. By the end of the 30 years, there is more than a $575,000 difference between the investor who reinvests the dividends they earn and the investor that doesn't, with all else being the same.

Here are the assumptions I made to create this chart:

  • Starting principal: $25,000
  • Annual contribution: $3000
  • Dividend tax rate: 15%
  • Annual dividend yield: 3%
  • Dividend growth percentage per year: 5%
  • Share price growth percentage per year: 3%
  • Dividend frequency: quarterly

In short, by reinvesting all of the dividends being earned, you are able to earn more in capital appreciation and dividends in 19 years than you would in 30 years of not reinvesting any dividends! Therefore, although this chart is misleading in the sense that consistent growth over 30 years is practically impossible, it demonstrates just how important it's to reinvest your dividends.

Minimum Dividend Yields

Select a dividend-paying stock with a starting yield of at least 3%. In general, I try to look for 3-4% starting dividend yields.

With higher investment budgets, you can go as low as 2.5%, and even 2% if the dividend-paying company meets all other criteria or has an above-average dividend growth rate.

If the starting yield is too high, this may be indicative of a "yield trap." This means that a company will pay a higher starting yield to attract investors, when they’re actually not doing well or have a lot of room to grow in the future.

Companies found in this situation are therefore not reinvesting their profits back into themselves. In cases like these, it’s likely that they company’s business model is out of favor, and probably not coming back into favor anytime soon.

One example of this is GameStop (GME), a video game, consumer electronics, and gaming merchandise physical retailer.

GameStop’s core business model of selling used video games in-person is relatively outdated, with less demand and with the rise of online video game markets. In this case, it’s safe to say that GameStop’s business model is out of favor, and they will likely cut their dividend in the near future.

Consistent Annual Dividend Growth Rates

You should purchase dividend growth stocks that grow their dividends ~6% year over year. This is ideal for dividend growth investing!

The current yield you see for the company you invest in will not do much for you. It’s only when you continue to reinvest the dividends you receive, and the compounding effect takes place, that you will see huge results.

Don’t chase companies with a higher dividend yield and necessarily think that this is your dividend amount forever. Instead, look for companies that increase it annually and are consistent about it.

For example, you should avoid investing in companies that increase their dividend yield 1% one year, 3% the next year, and 0% the year after. Instead, invest in companies that grow their dividend by ~6% annually instead. The longer a dividend-paying company has done this, the better.

Adequate Dividend Payout Ratios

You should invest in companies that have dividend payout ratios of around 50%.

Companies with too high of a payout ratio may be unstable or risky dividend investments, because they are reinvesting enough of their profits back into their company. Companies with too low of a payout ratio simply don’t pay their investors enough.

For example, a dividend-paying company that has a payout ratio of 20%, is a perfect example of a company that is not paying out enough dividends.

A dividend-paying company that has a payout ratio of over 70%, in some cases, may be a risky investment and indicative of a “yield trap.” Some of these stocks might in fact have a very nice looking yield, but it’s likely too good to be true!

Again, about 50% is sustainable, but this varies depending on the industry.

Long-Term Investment Mindset

You can have all the knowledge in the world on dividend investing, but unless you break it down step-by-step on how you're going to be applying the knowledge, then you will fall short on maximizing your dividend returns.

To begin, after you have invested into a dividend-paying company, the first thing you should do is to regularly keep track of this stock to see how it's doing.

Because this is a long-term investment that you should be confident in, and because you're investing in the company for the dividends which will take time to accumulate and grow, I would check in on the stock once a week at minimum.

This is to ensure nothing out of the ordinary is happening, such as a crash in the market. However, when this occurs, it may actually open up more buying opportunities for you. Moreover, checking on your dividend stocks only once a week will avoid any potential panic selling or buying behaviors.

Emotions and Investments

Do not get emotionally attached to your investments. Over a period of time, however long it may be, you may get emotionally attached to certain stocks in your portfolio. Whatever the reason for this may be, such as strong past performance or media hype, you may feel inclined to make investment decisions which are not actually in your best interest.

In situations where investors are emotionally attached to a stock, no matter how many warning signs they have telling them to immediately sell the stock, they will not do so because they are too confident in the stock and believe in the company to an absurd amount.

On the other hand, there are people who will buy and sell stocks in a short period of time, due to their emotions and stock price fluctuations. Obviously, you will not succeed as a dividend investor if you frequently sell your stocks, as it will drastically limit the double compound effect.

Again, you don't want to make investment decisions based on your emotions! If you do see yourself falling into this trap, be aware that the companies you've invested in are not your friend, and are only there to help you retire. So, if one is not making you money, you have to let it go.

The Bottom Line

In short, to really see the gains and benefits of dividend growth investing, you will need to invest tens of thousands of dollars into various dividend-paying companies in the stock market.

This is quite a substantial investment for most people. Therefore, you should ensure that your money is being maximized in the right ways, and without any additional risk.

So, if you follow the principles taught in this article, you'll be able to maximize your dividend returns in the long-run. This will move you one step closer to achieving your financial goals.

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