What are Dividends and Dividend Investing?

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On Friday, I sat at lunch with some friends talking about life, weekend plans, and personal finance. I’m a dork I know, but I found myself explaining what are dividends and dividend investing. So let me take a shot at this since I talk about them ALL the time.

What are Dividends?

Let’s start with what are dividends. Dividends are a portion of a company’s profits that are paid regularly to the company’s shareholders. The amount of profits shared among shareholders is a percentage of the stock price called “yield”. This is shared sometimes annually, quarterly or monthly to the shareholders depending on the company.

Dividends are popular because not only do shareholders of a company’s stock see the price move. They receive dividends just for owning the stock. It’s like a small bonus.

For example: Apple (AAPL) stock price is currently $100. Apple has an annual dividend yield of 2.27%. Shareholders will receive $2.27 throughout the year just for holding onto the stock. The neat part is shareholders will receive income from their investment without selling.

What Are Dividends Infographic

Why do stocks produce dividends?

First, not all stocks produce dividends. Stocks like Google and Amazon don’t produce dividends. Every company decides for themselves whether they want to or not.

Stocks like Google and Amazon don’t wish to produce dividends because they want to focus all extra capital for research and development. Typically younger companies like this don’t pay dividends. However if you look at Coca-Cola, while they do innovate, their extra cash is distributed as dividends because they found it’s better put towards dividends to attract more investors. Dividends are very attractive to investors because of compounding.

Let’s Talk Compounding!

The idea is that dividends will compound increasing your investment. Let’s say you invest in 50 shares of stock ABC at $100 a share with a 3% dividend yield, you’ll annually earn $150 per year in dividends. However if the stock increases its dividend 5% (not stock price value, but dividend yield), your $5,000 investment in 20 years will be worth $13,143. That’s a 162.85% gain! Here’s a great dividend reinvestment calculator.

That’s if the stock stayed the same price at $100, but typically the market increases annually at 7%. So both the stock price and dividend will increase. Cool right?

What is Dividend Investing?

Dividend Investing is the idea of investing in only stocks that produce dividends. The purpose being of living off the dividends produced by the stocks you own opposed to selling your stocks for money. It essentially creates passive income.

Let’s say you plan to live roughly till your 92, and you want to have $60,000 per year for retirement. If you retire at 65 you would need to have $1,620,000 (before taxes) saved up to spend $60k every year. Yet, by 92 you will have run out of money, totally broke, dirt poor.

However dividend investors use dividend yield to create passive income for retirement. In the same situation, a dividend investor would save a larger amount upfront, $2,000,000 in a portfolio of dividend stocks at a 3% dividend yield. That 3% yield will create $60,000 (before taxes) per year. If you never touch your principal (that $2,000,000) you’ll be able to keep receiving dividends every year, forever. So even if you live to 126 (oldest person in the world), you can rely on that $60,000 every year since people seem to keep living longer and longer. I personally plan to live to 182.

Dividend Investing is relying on a reoccurring stream of income that never runs out opposed to a stash of cash that will eventually run out. If you haven’t figured it out, I’m a dividend investor.

Fun Fact: All five of Warrant Buffett (one of the greatest investors of all time) largest stock holdings pay dividends. These are Wells Fargo, Coca-Cola, American Express, IBM and Wal-Mart. He lives on the buy and hold strategy. He invests in good companies that pay dividends and sits back and receives a paycheck. Sounds like a dividend investor to me.

I’m constantly wordsmithing on how to explain what are dividends and dividend investing to people. How’d I do? Any tips on explaining it better?

My Emergency Fund, Why I Keep $2,000 For Emergencies

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Early last year, following the January 17th post season game of Broncos vs Steelers, I recall reading Dave Ramsey’s “Total Money Makeover”. Yes, I was desperate.

In one of the first chapters, he goes on and on (he literally can not shut up about it) about having an Emergency Fund. Yes, others have mentioned it, but for me, Dave Ramsey was the first to tell me I need to get on this. He was my first.

Here’s the thing with Emergency Funds. Everyone seems to have a different way they set these up. Davvy-Poo Ramsey talks about putting money in an envelope under your bed for safe keeping to pull out in dire emergencies. His believes that if people have an emergency fund easily accessible, they will spend it. Apparently he believes his audience has no self-control, maybe they don’t, but I went a different direction. I will always love Davvy-Poo for starting on my Emergency Fund journey, but here’s where I deviate.

My Emergency Fund

I have everything electronic. I keep $2,000 in my checking account as my “Emergency Fund” where it’s readily available. I don’t have cash hidden under my bed like National Geographic’s Doomsday Preppers (how the mighty National Geographic has fallen).

My active checking account fluctuates between $2,000 and $4,000 each month to cover my monthly expenses. At the end of the month, anything over $4,000 goes toward my savings account and that into my dividend portfolio. Here’s what I mean (infographic below):

Emergency Fund Infographic-01

Why I set up my Emergency Fund like this?

I have a method to my madness. Two reasons why I set up my Emergency Fund like this:

  1. My checking account is immediately accessible for debit withdraw if needed. PLUS my checking account gains interest (albeit a small amount) my emergency fund is large enough I make about $0.20 each month. I couldn’t do that hiding cash under my bed like a caveman.
  2. The biggest reason is fees. Overdraft fees are ridiculous and I’ve done that a couple times when I kept extra cash in savings. Since my Emergency Fund is the base of my checking account, if I go over my monthly expenses, it just pulls cash from my Emergency Fund which is the foundation for my checking account. No OVERDRAFT FEES EVER.

How much do you need in an Emergency Fund?

This is where a lot of people differ on how much they should have saved in an emergency fund. For me, I try to have $2,000 in my immediate emergency fund. This will cover about 1 month’s expenses for me. My emergency fund essentially gives me enough time to access my stock portfolio if needed.

In case of a legit emergency, here’s what I’d actually do

I’ve never had a legit emergency that’s affected my income (I’m young and invincible), but if I ever did, I have a plan.

  1. I would have immediate access to $2,000 in my checking account
  2. I would have immediate access to my emergency fund of $2,000 also in my checking account
  3. I would have semi-immediate access to my saving account which usually holds $4,000. It’s a semi-secondary emergency fund. This also makes interest =)
  4. That would give me time if needed to sell stocks and access my portfolio currently made up of $7,000.

With my average monthly expense of 2,000. My emergency process would cover me for 7.5 months if I could make no money what so ever. That’s pretty cool! Yes, I have friends and family that would be willing to help, but it’s important to me that I could support myself.

How do you set up your emergency fund?

Getting Caught up with Recent Buys

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Not going to lie to you, keeping up with a blog is tough. I’ve been slacking on you WalletSquirrel. WalletSquirrel grew from such a GREAT concept of earning money beyond the day job and I need to play catch up a bit with my most recent stocks before I continue my financial freedom journey.

Recent Buys

I went against my better judgement bought an oil stock. I bought The Chevron Company (CVX) for 4 shares at $90.01 with the intention of hoping on the bounce back of the oil market. I liked it’s $11.33B they had in total cash and they were using this downtown as an opportunity to restructure and run a leaner company. Plus I loved the dividend yield of 4.54%. However once I bought it, it was still fluctuating all over the place and when I asked myself, has the oil industry really bottomed out? And since I know NOTHING about the oil industry, I pulled out of Chevron at $90.94 for a $11.72 profit.

I do this whole, impulse buy and sell right away, A LOT. I need to work on impulse control, but while I keep making money it’ll be hard to stop. Especially with a $0 trade fee each time with Robinhood.

Lemur Pounce

Otherwise I’ve really been averaging down with a lot of stocks. This last month I’ve averaged down with Clorox (CLX), Wells Fargo (WFC), Coca-Cola Corporation (KO) and Verizon (VZ). Now what was the main reason I averaged down? Frankly I had the capital and didn’t have time to do the in depth research. I’m not sure if this was a bad plan, but I knew I liked these companies and while their stocks were down, I pounced. Like a lemur.

SE vs SEP, My First Journey to into Oil & Gas Stocks

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So everyone and their sister is talking about oil prices. Are they bottomed out or what not and to get in now while the prices are low. So how do I get into this action?

While I’m still learning about the oil players, one company has come to my attention thanks to Motley Fool, and that’s Spectra Energy (SE). I know what you’re saying, why are you even listening to the Motley Fool and frankly it’s just because I like the amount of info they give me. So when they bring up Spectra Energy, I find it as a good starting point into oil and gas.

Spectra Energy (SE)
In essence, Spectra Energy is a natural gas company that operates in the transmission, storage, distribution, gathering and processing of natural gas. They were originally apart of Duke Energy but spun off for tax reasons. I think of Spectra Energy as a natural gas company that operates along the east coast providing natural gas from the Gulf of Mexico and Texas all the way up the east coast through New York and Maine.

Now slightly confusing

Spectra Energy Partners (SEP)
Spectra Energy is the natural gas company and they created yet another spin off of their actual pipeline transmission known as Spectra Energy Partners which is a MLP (Master Limited Partnership). They essentially own the pipelines and charge companies to use their pipeline highway, essentially like a toll. Think of Kinder Morgan except without the major losses right now, SEP is fairing slightly better than KMI right now.

spectra-energy-partners-lp_large

SOURCE: SPECTRA ENERGY PARTNERS, LP.

Now I did buy 3 shares of SE at $27.44 because who wouldn’t want to get into the high exciting world of natural gas. The idea is I will build my position in SE while the stock is down and keep building until oil prices bounce back to normal (whatever that is). Plus at a dividend yield of 5.70% I will enjoy my lovely dividend. Life is good.

My Dividend Investing Strategy

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Screw chasing yields, I’ve never been into that. Usually high yields means the company is bleeding money. You’ll see some dividend investors taking large stakes in companies with over 15% yields. That’s just crazy. They’ll usually see their investment dwindle down because most companies can’t support that.

Here are the rules I follow:

1. Only invest in dividend paying stocks – I eventually want to live off the dividends my stocks produce. I would love to invest in stocks like Amazon and Adobe because I believe they have such a great strategic advantage and I’ll continue to see them do well, but they don’t produce dividends. It’s really, very sad. Just Google “if you invested in Coca-Cola in 1990” and you’ll see how a dividend producing stock will produce a better return than your average stock. It will have its annual increase PLUS it’s dividend to grow its stock. I never want to try to TIME THE MARKET selling off shares at the right time. I’m more interested in streams of income than buckets of income.

2. Windfalls should be invested in existing stock – You’re going to find yourself with certain windfalls. Sometimes it will be a large paycheck from a side hustle, sometimes it will be an inheritance or whatever the windfall it should be. You’ll want to spend that money all at once. It’s money you didn’t have before so why not use it to buy a butt load of stock? Problem is, you’ll want to buy stocks all at once and you’ll go on a spending spree. To save yourself from buying stocks you don’t know too much about, reinvest in the stocks you’re currently invested in. These are stocks you’ve vetted before, you’re better off reinvesting in them with your windfall. Whenever I receive a large paycheck ($200 is large for me) from a side hustle, I will reinvest into stocks I’m currently already in bed with.

3. Will the company be around in 50 years? – I’m slightly stealing this one from Warren Buffet, but the trick to not going crazy watching stock prices is investing in companies that will be around in 50 years. Invest in companies that you believe will succeed and ignore all the market fluctuations. That is the trick for me. I don’t pay attention to the temporary ups and down of the market. I plan to invest in the companies I believe in and take in the monthly paycheck. I always recommend you do quarterly updates with your stock/companies to make sure the CEO isn’t embezzling from the company or anything and your stock price isn’t plummeting.

4. Don’t sell your stock – You’ll be tempted but you got to know that you’ll make more if you don’t. If tempted, just look back at the graphs and you’ll see that stocks constantly fluctuate. Up and down and back again, but usually with 7% annual growth if we factor in the S&P annual growth. Just think about the people who gained so much by continuing to hold Coca-Cola through all the recessions. If you believe in the company, let it be and just keep collecting the dividends. Now if the company quits it’s dividends, then you should consider selling, but use caution. Otherwise sit back and enjoy!