Why Dividends Are So Great For Building Your Net Worth

I may earn money or products from the companies mentioned in this post.

Man, I really wish I knew about dividends when I first started out investing. I mean, I know it took me only like 2 years to take them seriously and to actually understand how they work, but still, I probably missed out on a solid $40 or something!

Before I had any idea, dividends to me were something old people at the country club would talk about. All I heard people older than me bring up, was what the yield of a stock was and how it was amazing that a dividend yield in a certain stock was 3% or even more. All I kept thinking was first of all, what the hell does that even mean, and second, who even cares, that stock is too expensive. And by expensive, I literally meant it had to be anything over like $95 regardless of what the company was, what they did, etc.

Solid principles, right? Whatever, I got mine after I read all those books!

 

Dividends are the best

But in all seriousness, dividends are immensely helpful when building your net worth, especially for retirement. Of course, you don't want to buy a stock just for the sake of having a dividend. General Electric, for example, has a dividend yield of 3.40%. That seems awesome until you realize the company is kind of in shambles going through an extreme makeover right now.

GE doesn't even have a price/earnings ratio right now. That means the company is losing money. You don't ever want to invest in a company just because it has a high dividend yield relative to other stocks. General Electric is a perfect example of that, for the time being.

And on a side note (since this is definitely worth a post of its own someday), just because a dividend yield got smaller, doesn't mean you shouldn't invest in that stock.

Like for example, on 8/10/17, Apple's stock price was $154.14. The payout was $2.37 per share yielding a dividend of 1.54%.

On 11/10/2017, the stock price went up to $173.97 and the payout increased to $2.44 (yay!).

But the dividend yield decreased to 1.40%. But who cares?? That doesn't mean the company is cheap, it just means the stock and hopefully the company are doing well. It has nothing to do with the willingness of the company or lack thereof, to increase dividends. Nor was it even in between quarters like the first and second or something where dividends are usually increased if at all.  The price rose that high within the third quarter of the year.

Dividends can be very misleading in my opinion when you look at them solely from the perspective of a yield. I don't take them as seriously as others do.

With that being said, however, if you are curious, to get you started…

Here are examples of a few companies who pay dividends and how much at the time of this post:

• Apple: Yield: 1.41% Quarterly Dividend: $.63
• Microsoft: Yield: 1.78% Quarterly Dividend: $.42
• Costco: Yield: 1.05% Quarterly Dividend: $.50
• Coca-Cola: Yield: .55% Quarterly Dividend: $.25
• Goldman Sachs: Yield: 1.12% Quarterly Dividend: $.75

 

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Benefits of Dividends:

As a long-term investor, and essentially what this blog is all about, dividends can provide you with a steady income when you retire years later or even if times are tough down the road.   But that'll only happen if you've been a diligent saver and investor over the years.

That's why I always say to reinvest your dividends. Think of it this way, it's essentially free income you get to put back into your stocks to gain even more interest on top of the principle and interest from the performance of the year. This is assuming the stock/index fund went up of course.

Think of it like a 401k contribution plan for yourself. The more you invest in a dividend stock, the more you'll get free money back.

But always make sure you select to reinvest your dividends once you buy either an index fund or a stock. My default in my account was to not reinvest, so I had to manually change the settings to reinvest all my dividends.

Another huge benefit is dividends are usually less volatile than earnings over time. Companies that offer dividends don't like telling investors that they're not going to receive them anymore, so the companies keep issuing them unless some huge crisis happens; which usually means those companies have a lot of cash on hand anyway and can ride out the tough times.

Even if the stock hasn't done great, like Coca-Cola hasn't in the past year with a 2.26% performance vs the S&P 500's 12.42% performance at the time of this writing, if you have enough shares of Coca-Cola, it really doesn't matter.

This is obviously an extreme example, but just to prove a point, even though the stock increased just 2.26%, Warren Buffett earned $148 million in dividends alone from the soft drink.

As mentioned before, you tend to benefit from the increase in the stock price, because companies usually increase their dividend from time to time, usually during a new quarter. It may not be every quarter when the stock rises, but as long as the dividend doesn't decrease, that's always a good sign.

If for whatever reason you choose not to reinvest your dividends, a nice perk is what's called the “qualified dividend” rate. Rather than paying regular income tax on the cash, you pay a rate of either 0%, 15% or 20% depending on your tax rate. Having this option allows you to keep more money!

But, I highly advise against cashing out and think you should always reinvest dividends.

 

 

 

Here's a great example of what your hypothetical rate of return would have been with a $10,000 initial investment in a company called Realty Income Corporation over 22 years from 1994-1996:

How's that for an eye-opener?

Even for me, I just got my 1099 a couple days ago for my taxes and I made $548.78 in dividends and had them reinvested. I didn't even do anything! That's the best part!

No actually, the best part is last year my dividends totaled in the $300's, and this time the total was about $200 more. How awesome is that?

It feels great knowing I did nothing this whole year to earn that money except leave my investments alone until the correction came.  Then, I invested a little bit of the cash I had on hand.

Actually here's another example that makes me laugh. I can see my dad's mind racing thinking “what if” every time he tells me this story of his friend who he had lunch with one time last year.

They were just talking, and the guy was going into early retirement. My dad asked him how he was able to do it, and he said the best thing he ever did was invest early in his 20's. He put money in blue-chip stocks with solid dividend histories and index funds, and he made sure to reinvest the dividends.

He told my dad last year he made over $200,000 in dividends alone…

Think about that. That's like 4x an adult's salary, even more in some cases.

Of course, this means he has something like $10 million invested in stocks if the yield is 2%, but this just goes to show you how important it is to start as early as you can!

If you make more early on, you can save more and invest more. It's really as simple as that. The trick is to be disciplined enough to stick with it and not always go out to eat or go to the bars.

And remember to always choose the option to reinvest your dividends!

What do you think, are you going to start reinvesting your dividends if you aren't already doing so? What're your thoughts on them?