You should all be well versed in all things stock market because you have read the first three articles in the series. If you haven’t read those yet, you can find them here: 101, 102, and 103.
Now that you are all caught up, we need to create a plan before we actually start investing. Since we are investing for dividends, there are a few things that we need to consider before we begin.
Time horizon. When do you want to start using the income from your investments? How long do you have? These questions will decide the types of securities that you will need to leverage in order to achieve your cash flow goal.
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Cash Flow goal. How much cash flow are you trying to create from your dividends? Remember, using the retirement 4-50 plan, you have 4 sources of cash flow.
- Retirement income. This is income from a pension, social security, and retirement accounts like 401Ks, thrift savings plan, and Roth IRAs.
- Rental Income. Rental Income from real estate.
- Investments. Dividends and bond interests.
- Business. Income from a business and royalties from created content.
Using your total retirement plan, you can decide how much of this cash flow should come from investments. For this article let’s focus on $1,000 a month of passive income from dividends.
Risk-aversion. This is similar to your time horizon, but this is more of your personality. Some people just don’t want to take much risk. That is okay, you can still be very successful in the stock market without taking a lot of risks, you will just need more money.
Now that you have your goals, timeline, and risk all planned out, you need to educate yourself on the types of products that are available. There are many products out there. The sheer amount of choice is what keeps most people away from the stock market. Refer to Stock Market 102 to help you cut through the noise and help educate yourself on these products: stocks, bond funds, electronic traded funds, real estate investments trusts, mutual funds, closed-end funds, and preferred shares.
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I like to start building my portfolio by using monthly-paying securities. Having monthly payers helps build a solid base of income and I would recommend that you do similar.
For example, if your cash flow goal is $1,000 a month, you may want to have $500 a month from monthly payers. That way, you can pay your major expenses with your monthly payers. This is where your education will start to come into play.
If you are going for a high-yield monthly payer, you should not expect the price to appreciate too much. For instance, my favorite closed-end fund is Pimco Dynamic Income Fund (PCI). It currently has a dividend yield of 10%. The price usually ranges from $18-21. When it gets closer to $18, I buy more. You would buy PCI purely for the income. However, you wouldn’t want to try to reach your $500 monthly income goal with just PCI.
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Closed-end funds are riskier than some other products because they use leverage (debt). That means they are extremely dependant on interest rates and can be volatile. These are things you will learn over time. For more on closed-end funds read “How to Retire on Dividends” by Brett Owens
So within your $500 a month goal, you can split that up into different securities types, sectors, and risk types. Your portfolio of monthly payers can look something like this.
- Closed-End Funds
- Pimco Dynamic Income Fund (PCI): Mortgages and Income
- Reaves Utility Income (UTG): Utilities
- Nuveen Municipal Bond (NVG): Tax-Free Municipal Bonds
- Mutual Funds
- Artisan High Income (ARTFX): Banking/Financial sector
3) Electronic Traded Funds
a) Global X Superdividend (SDIV): Global Dividend-payer
b) Invesco Preferred ETF (PGX): Preferred shares
c) High Yield Bonds (JNK): Junk Bonds
d) Long Term Bonds (BLV): 30+ year bonds
4) Real Estate Investment Trust
a) AGNC (AGNC): Monthly paying mortgage REIT
Your $500 monthly dividend-paying portfolio is now built. You are well diversified in case of an economic downturn. You have some high yield payers and some safer products like bonds. You also have REIT exposure.
Next, we need to layer on our quarterly paying stocks. These are usually individual stocks. The good thing about buying individual stocks is that they also increase their dividends over time (if you pick the right companies).
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You want to look across the field of dividend-payers and pick stocks that have various histories of paying dividends. What this means is that most companies that pay large dividends are not growth companies. Their days of growing the dividend by large amounts have passed.
Don’t get caught in the yield trap. This means buying companies only for large dividend yields. You want to have an assortment of companies. I break them down into 3 different categories. You can do it differently, this is just my method.
- Low dividend payers. These payers are new to paying dividends and the dividend yield is very low. However, the dividend increase per year is pretty high. Companies like Microsoft (MFST) and Apple (APPL) pay a very small dividend but will increase over the years. The dividend yields are roughly 1-2%.
- Medium dividend payers. These companies have been around a while and have also paid a dividend for a long time. However, they are not a dividend-first type company. They still have growth in the price of their shares. Companies like McDonald’s (MCD) and Proctor & Gamble (PG) come to mind. The dividend yields are usually 2-4%.
- High dividend payers. The only reason to own these companies is for the dividend yield. However, they are good companies with good cash flow. You want to research into their cash flow and what percent of profits is paid out in dividends. Companies like AT&T (T) and Phillip Morris (PM) come to mind. The dividend yield is usually greater than 5%.
By layering the different types of dividend payers, you are getting high income now and also preparing your portfolio for the future. Eventually, your high payers will go away, and your low payers will become your high payers. At that point, you will have a new batch of low payers.
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That is what makes dividend investing so fun, watching your portfolio grow as your education grows. Let’s look at the different quarterly stocks and their cash flow.
- Jan, Apr, July, October
- Carrier (CARR): Low
- Medical Property Trust (MPW): Medium
- Cisco (CSCO): High
2) Feb, May, August, November
- Papa John’s (PZZA): Low
- Ally Bank (ALLY): Medium
- AT&T (T): High
3) Mar, June, September, December
a) Wendy’s (WEN): Low
b) Johnson & Johnson (JNJ): Medium
c) Vector Group (VGR): High
Your portfolio is starting to come along. The final part is to layer on some growth. I like to use index funds for my growth vehicles. They are safe and they pay dividends as well. There are 4 main index funds I buy. Growth plus dividends is a great combination.
- Vanguard Total Stock Market ETF (VTI): Dividend yield 1.42%
- SPPR S&P 500 ETF (SPY): Dividend yield 1.52%
- SDPR Dow Jones Industrial Average ETF (DIA): Dividend yield 1.87% (pays monthly)
- Invesco Nasdaq 100 ETF (QQQ): Dividend yield 0.55%
You can adjust your exposure to different sectors, different yields, and different payment periods. Building your own portfolio gives you as much customization as you want. Practice building a simple portfolio.
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In your simple portfolio add the following parts:
- Monthly paying fund
- January paying stock
- February paying stock
- March paying stock
- Index fund
There you have it. You have your very own portfolio. Watch it grow. Remember, the first step is finding out what your goals are. From there you can build your portfolio with as much risk, or lack of risk, that you are comfortable with. Education is vital to success.
For Stock Market Investing 105, I will look into the different investment platforms and what makes each one unique. See you in the next one.
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