How To Compound Your Dividends Monthly
One of the main strategies employed by my premium newsletter, The Daily Paycheck, is dividend reinvestment.
Thanks to the power of compounding, every dollar of income we reinvest back into the securities that pay them accumulates our money faster. Even one reinvested dividend makes your position bigger and its income generation potential larger.
In the simplest terms, dividend reinvestment can make you richer quicker.
The beauty of this strategy is in its simplicity. When you reinvest dividends, you put more money into the security, and this larger position pays you more the next time its dividend is due. This cycle continues for as long as you are willing to hold the security and delay pocketing the income.
Easy enough, right?
But there is more to this strategy than you might realize at first. For instance, when you reinvest dividends, the frequency of the payments matters.
Let me explain…
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Behind The Numbers
To help show you what I mean, I ran a dividend reinvestment strategy for two hypothetical stocks. Let’s say you have two stocks that both yield 10%. They cost $120 per share at the beginning of the year and do not appreciate at all by the end of the year. (In other words, the price of this hypothetical security does not change over the course of the year. This allows for an easier comparison of the total return for each security.) Now, let’s say you buy 10 shares of each stock…
The only difference? One pays a monthly dividend — while the other pays the more traditional quarterly dividend.
At year-end, the total amount of dividends received from the first security will be $125.66 and its effective yield will be 10.47%. For the other security (the one that pays dividends quarterly) the results are somewhat lower: $124.60 in total dividends and a 10.38% effective yield.
Not much difference, right? But this adds up over time.
The next year, the monthly payer would start you off with a slightly larger amount, which will then be reinvested again. In five years, the difference will be even more pronounced: For the first security, with monthly dividends, your effective annual yield will be 15.6%, clearly better that the 15.4% annual effective yield for the quarterly payer. (In dollar terms, that’s $187.10 vs $184.90.)
The principle is the same: Dividend reinvestment pays, but every little bit counts. So all else being equal, monthly dividend payers are clearly superior.
If you’d like to play with the numbers yourself, this easy calculator will allow you to input your own numbers and see how much the frequency of distribution matters, especially in the long run.
But here’s the thing… there is more to monthly payers than just the possibility to faster accumulate dividends.
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For investors who reinvest dividends, monthly reinvestments minimize market risk — specifically, the risk of reinvesting at peak prices — and opportunities for second-guessing.
Another good reason to like monthly payers is the easier decision when it comes to selling. You don’t need to wonder if you should wait months for the next dividend to be paid. With 12 payments in a year (and each one is relatively less important than a quarterly payment), the decision to sell would be easier, should it come to that.
Also, monthly payers offer big benefits to income investors, especially those who count on this income to pay bills and cover regular expenses.
Now, you’re probably aware that most U.S. stocks pay quarterly dividends. This schedule is related to the way public companies’ financial reporting is organized: Companies report their earnings quarterly, and they pay dividends on a similar schedule. But for investors, receiving monthly income is simply more convenient than receiving it quarterly (or semiannually, which is how most foreign stocks pay their dividends).
A select few equities do pay monthly, and we own a lot of them in our Daily Paycheck model portfolios. (One of our top-performing holdings even labels itself “The Monthly Dividend Company”.) But the majority of monthly payers are funds, both exchange-traded funds (ETFs) and closed-end funds.
All told, we own 17 securities that pay monthly dividends — yielding between 5% and 9%. So if you’re looking for quality monthly dividend payers, they’re out there — you’ll just have to do a little searching to find them. (By the way, if you’d like know which ones we hold in The Daily Paycheck, join us today to learn more.)
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