I was super excited last month because when I reviewed the brokerage account statement for March, I worked out that my dividend income was almost £800 ($1,100) after tax. It came at a timely moment because I had just finished writing a guest blog for Real Money Robert on the topic of dividend investing.
To put that into perspective, here are 6 cool things you could do with that payout:
- A next day economy return tickets between London and Rio de Janeiro (although it would take almost 30 hours with a stopover in Houston)
- A night at the following boutique luxury hotels
- Pay for 40 Rhino Rangers’ salaries for 10 days according to WWF
- Covers 85% of my mortgage repayment for a month
- Rent this studio apartment in quite a central area in London for 2 months
- Drink 235 pumpkin spice lattes from Starbucks and never do that again, according to CNBC.
As you can see, quite a diverse range. I’m sure if you Google “what could I do with $1,000“, there will be more ideas than time available to pursue them.
Obviously I don’t get that every month as my portfolio is not 100% invested currently (I received less than $200 / £120 in January for example) so I won’t get ahead of myself too much. But still, this is the first time that I’d broken the £800 mark. My aim in the next 2 years is to get £1,000 monthly dividend consistently. Quite a bit of saving to do still.
So which of these fun-inducing activity should I pursue? This is a tough one. Or maybe not!
What is dividend?
Just to recap, dividend is profits made by the company that is distributed to its shareholders, normally in the form of cash. It is one of the most passive form of income and my favourite.
There are essentially 2 things I could do with my newly minted dividends:
- Spend it
- Reinvest it
Spend your dividend
Well this is easy.
Most brokers give you the option of paying out the dividends directly into your bank account.
Select that option, sit back and enjoy seeing cash turning up at regular intervals.
Dividends are usually paid out quarterly and each company has a different accounting starting point so if timed well, you could achieve consistent monthly payouts.
Then there’s always the Realty Income Corporation, which is a REIT that pays out a monthly dividend. In fact it is such a prominent and unique feature that it actually trademarked the phrase “The Monthly Dividend Company“! I’m not saying that you should base your investment thesis purely on its dividend payout frequency but given that it is also a company with solid real estate assets, I highly recommend investing in it at a reasonable price point.
Once you’ve paid the due taxes, then the money is yours.
- Want another beer? No problem.
- Need another iPhone? Well if I hit my 2-year dividend target then I could get a new one every month!
Sadly I don’t drink that much beer and I can really do without changing my phone monthly so instead I will be going with Option 2, which is to reinvest it..
Reinvest your dividend
The concept of dividend reinvestment is super simple:
- You receive dividend;
- You use that dividend to buy more shares;
- Now the total number of shares you hold has increased;
- Since dividend is calculated on a per share basis, this (hopefully) will increase the total amount of dividend you receive over time, which allows you to buy even more share;
- With more shares, your capital growth potential also increases.
So we achieve a virtuous cycle of more dividend more shares and even more dividend payout.
This is known as compounding and it makes an enormously difference to your portfolio return over time.
Source: The Motley Fool
This graphs shows what would have happened had you reinvested your dividend in the shares or in beer. As you can see, compounding has makes an enormous difference to the total value of your portfolio the longer you stay in the market. The annoying thing with compounding is that it’s slow, very slow initially. You will hardly notice its effect in the first decade, however once you had passed that mark then it will accelerate and becomes faster and faster until you wake up and realise “what the f*ck!?”.
This is an excellent article explaining how compounding works, albeit using fold paper as an analogy.
Now there are 2 ways you can reinvest your dividends:
- Hold on account, accumulate to a certain amount and then buy more shares
- Using a Dividend Reinvestment Plan (DRIP)
I started off doing #1 because like most people, I had never heard of DRIP. It was always more reassuring to see some hard cash in my account and deploy them with my full knowledge. However soon I found some shortfall in this method:
- DRIP charges a much lower commission than non-DRIP trades. Given that my average dividend cheque is around £150, a £10 commission puts a 7% dent in my position. Not ideal.
- #1 relies on me regularly reviewing my position and remind myself to reinvest my dividend, which can be a chore.
So I decided to try out DRIP with my broker, which turned out to be as easy as clicking a button. It automatically reinvests my dividend on a monthly basis with a 1.5% commission (min £1, capped at £10) and the above 2 problems instantly went away and I could simply pull back and put my portfolio on autopilot.
Amending dividend instruction was super easy
The one major downside with DRIP is market timing. DRIP works at such low commission because your broker has a predictable trading volume from all the dividends it collects from its clients. The broker therefore can tell you exactly how much dividend it will be reinvesting in each share for the following month. This level of certainty combined with high volume means a lower trading cost which gets partially passed onto investors.
However it also means that investors can not choose at which point does the dividend get reinvested. It will simply have to be the next calendar month. This works great if we are in a bear market when there are more bargains however it also means we will be buying at a premium in a bull market.
Whether you are comfortable with this approach depends on your perspective.
There are plenty of studies which show that the amount of time spent invested in the market (thus capturing bull and bear runs and crucially the recovery) plays a more significant part to your return than timing.
So you can disregard DRIPing a small amount at a premium. Personally I believe in this school of thought because I simply do not have the foresight, intelligence nor time to do the homework and time the market.
Dividend is my favourite form of passive income because it is as passive as it can get. Once you’ve received it, spend it or reinvest, your call, because put it simply, you’ve earned it!
What do you do with your dividends? Would love to hear about your stories. Please comment away.