Dividends: The commonly forgotten source of free money.

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In the world of stock investing one of the topics that I believe is most often forgotten is dividend returns. What is most talked about is stock prices and the interest returns that are gained on a yearly basis, with the small chunk of free money that is consistently given known as dividends left by the wayside. What got me thinking about this recently is that I looked over my returns for 2019 and realized that I had earned $2,800 in dividends!  For those of you who arent familiar with what dividends are, they are basically money that companies give their investors as a perk for investing in their company. Most often the dividends are based on how much profit a company earned in that given year and other times they are a consistent percentage that a company gives to reward its investors. 

It seems to me that over the years that I have been investing in the Vanguard Total Stock market index fund (VTSAX) I have received on average between 1-2% of the total amount I had invested in dividend returns. Initially this was just a few dollars but now that I have over $200,000 invested the number is getting bigger and bigger. You can relate this to the interest rate your local bank gives you for having money in something such as a savings account. My local bank currently offers .01% or basically nothing…. 

What is great about dividends is that you are simply earning free money for investing. I was very surprised to see that I had earned almost $3,000 especially because VTSAX isn’t known for paying high dividends. It just showed me that having the discipline to invest and put my money away is definitely paying dividends… pun intended. 

The reason I think bringing dividends up is important is because I think it is something that your average beginning investor doesn’t think much about. On the other hand if this person were offered lets say a rewards credit card where they were given $200 per month in free money I think they would jump on board immediately. Dividends are in a way very similar, it just takes a little longer to get to that amount.

As my portfolio continues to grow I expect in about 5 years for that dividend payment to start paying out close to $10,000 per year. This is huge especially for someone pursuing financial independence because it will account for approximately 33% of my expenses. Thats one third of my annual bills that will be covered by free money just given for having my money invested.

What to do with these dividend returns 

Here you have two options as to how you can handle the money you get from dividends. The first and recommended option is that you reinvest the dividend earnings. What happens is that whatever fund or stock you are invested in will electronically wire you money which usually happens quarterly. When this money is sent to you it will automatically go back into your investment fund and purchase more shares or stock in the fund or company you are invested in.  You can make this happen by going in the settings portion of your investments and picking the option “reinvest dividends”. By clicking that option all future dividends will automatically be reinvested without causing any further action from you. The best part about this option is that the free money you have earned from dividends will now compound and grow at an even faster rate. 

Option two is that you choose to have the dividend payments paid out to you. What this would look like is that your investment company which in my case is Vanguard would either directly deposit the dividend earnings in your checking account or they would send you a check directly to your home. This option is great for when you are actually in retirement as it helps cover your expenses without touching your lump sum of investments. As I mentioned before I plan to have about $10,000 in dividend returns in approx. 5 years. What I will do is have that money wired into my checking account at that time and will be able to use it to pay bills, cover vacations, or any other discretionary spending I may have. This will lighten the load on the amount of money I need to withdraw from my investment accounts to cover my annual expenses allowing that money to grow even more. 

What funds or stocks pay the highest dividends? In this area I am familiar again with two different options. The first option is investing in an index fund that specifically targets dividend growth. Vanguard has a fund like this called the Vanguard Dividend growth fund. This fund specifically targets stocks that have a good track record of paying high and consistent dividends to investors. This is a good option for those looking to have an easy well diversified fund to invest into that is known for giving good dividend returns. The second option is investing in individual stocks that are a part of a group called “Dividend Aristocrats”. Dividend aristocrats are stocks that are part of the S&P 500 meaning the 500 largest companies in the U.S. that have consistently increased their dividend payments to investors for at least 25 consecutive years. This is a pretty impressive feat for a company to make and it makes them even more prestigious to investors, as the companies have shown a track record of treating their investors well and rewarding them for investing in them. The list of these stocks can be found here :

https://www.dividendgrowthinvestor.com/p/dividend-aristocrats.html

Takeaways

What I hope the main takeaways from this article are are

  1. The stock market does not have to be a scary thing to invest into, it will actually pay you a reward for investing. 
  2. Try to avoid keeping a large chunk of your money in a checking or savings account where you won’t be able to take advantage of dividend and interest returns. 
  3. Reinvest dividends as you’re accumulating wealth, then take advantage of them in your retirement or FI years to help pay for annual expenses. 
  4. Don’t get discouraged by small dividend payments initially as they will grow into thousands of dollars per year as you accumulate more wealth.  

I wish you luck in taking advantage of these dividend payments in the future, if you have any questions please feel free to email me or leave a comment. 

Thanks for reading, 

Matt 

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4 comments on “Dividends: The commonly forgotten source of free money.”

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