What is Dividend Investing?

by TerriRexson

What is dividend investing? In this article we'll take a look at the role that dividends can play in your investment portfolio.

An Introduction to Dividend Investing

In this article we'll take a look at dividend investing. Dividend investing is a long-term investing strategy aimed at generating income from a stock portfolio. 

Don't worry, we'll start from basics and go through the concepts involved. This will give you some input to help decide whether dividend investing might be appropriate for a part of your investment strategy. 

What is a Dividend?

A dividend is a payment made to shareholders of a company. If you own stock in a company, i.e. you have bought shares in that company, then you are a shareholder and may receive dividend payments. 

Dividends come from the profits in a company. A company may reinvest some or all of it's profits. It may choose to return some of the profit to its shareholders as a dividend payment. 

What is Dividend Income?

Dividend income is the money you receive in dividend payments. It's a form of passive income and if you have enough of it then it can fund your retirement. 

If you build up enough dividend income then you'll be able to retire early. Wouldn't that be nice? A nice dividend payment appearing in your bank account each month. 

Of course to achieve that, you're going to have to build up a stock portfolio that generates sufficient dividend income. 

OK, So What is Dividend Investing?

Dividend investing is maintaining a share portfolio with the goal of generating income from dividends. For many the goal is to generate sufficient income each month that they can cover their expenses in retirement. 

The idea is that you have a portfolio of shares that makes regular dividend payments. Your whole portfolio needs to generate enough money each month to cover your expenses. 

You want to avoid too many months where you have to dip into your capital (either by selling shares or using other savings) and ideally hope to generate more money than you need each month. 

In dividend investing your focus is more on the potential to generate dividend income than the potential for share growth - you don't plan to sell the shares, you plan to keep them and live off the dividend income. 

Serious about Dividend Investing?

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How do I know how much Stock I need to live off Dividend Income?

So how much stock do you need to be able to live off the dividend income? That's a tricky question. It involves lots of variables including how much money your lifestyle costs and the tax laws in your country. 

But if you're just starting to think about dividend investing then a ballpark figure is probably useful. Jacob at early retirement extreme suggests the following formula for general invested savings:

your annual expenses < 3% of your invested savings

in his Can I retire young? post. Obviously you need to keep rerunning this calculation as your expense predictions change with inflation and lifestyle choices and your investments (hopefully) increase in value. 

With dividend investing you're less concerned with the value of your stocks than the value of the dividends that they generate. This is evaluated in terms of dividend yield. 

What is Dividend Yield?

Dividend yield is the percentage of the share price that is paid out in dividends each year. It is calculated by dividing the annual dividends per share by the current share price. 

For example if a stock is valued at $40 and pays out $4 per year in dividends then it has a 10% dividend yield. 

Dividend investers look for stocks that are likely to have a consistent long-term good dividend yield. 

Be careful! Don't just jump in and buy because the dividend yield looks good today. You're going to need to do your research on the company or take advice that you trust. You're looking for long-term performance here. 

Dividend Investing as Part of Your Investment Strategy

I'm not a financial advisor, just someone who likes to make the most of her money. I consider dividend investing to be a sensible strategy for a part of my retirement income. 

Investing for share growth is talked about more, but I think dividend income is a good way to fund a substantial part of your retirement. 

Dividend Reinvesting

What do you do with dividends while you are building up your retirement portfolio? A sensible option is to reinvest the dividend payments in order to grow your portfolio faster. 

You can also use this approach during retirement for any months where your portfolio generates more dividend income that you need to live on. 

Further Reading on Dividend Investing

Dividend Stocks For Dummies

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The Basics of Stock Investing

If you need to get a basic grounding first
Stock Investing For Dummies

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Investing Online For Dummies

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Updated: 01/01/2012, TerriRexson
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