A Simple Strategy to Boost Dividend Income

In each issue of High-Yield Investing, we include a “Dividend-Capture Dates” section.

The strategy is pretty simple: You buy a dividend-paying stock right before it’s about to go ex-dividend and hold it for at least 61 days so the income qualifies for the lowest possible dividend tax rate. Then, sell it and use the money to buy another stock that’s about to go ex-dividend.

With the right timing, investors can grab huge special payouts when a company puts in a strong performance or is restructuring. There’s one problem, though. Once the stock goes ex-dividend, the share price typically drops by at least the amount of the dividend. Some stocks fall even more after offering large payouts, and there are no guarantees they will recover. When that happens, you could end up losing more from the lower share price than you made in the dividend.

#-ad_banner-#While there is no surefire way to mitigate the entire risk of the dividend-capture strategy, investors can alleviate some of the downward pressure of the approach by rotating in and out of stocks.

Here’s what to do: Pair two stocks that pay quarterly dividends at different intervals and hold onto each for the minimum required 61 days to get the reduced dividend tax rate. By doing so, you’ll squeeze out two extra payments a year with the same investment capital.

Let’s say “Stock A” and “Stock B” each sell for $100 per share and pay a 12% dividend yield (ir32h delivers a total annual payment of $12 a share). That equates to a dividend payment of $3 a share each quarter. By rotating in and out of the two stocks, you can capture six tax-advantaged quarterly dividends each year, or $18 a share instead of $12. In other words, you can boost your yield from 12% to 18% by rotating in and out of these two stocks.

Here’s an example of how it might work. Say you buy “Stock A” before it goes ex-dividend at the end of December and sell it at the end of February. You pocket $3 a share from “Stock A.” You then use the money you get from selling “Stock A” to buy “Stock B” before it goes ex-dividend at the beginning of March and sell it at the end of April. You pocket $3 per share from “Stock B.”

You rotate in and out of these two stocks six times, buying one just before it goes ex-dividend, holding it for the minimum required 61 days, selling it after you’ve pocketed the dividend, and using the funds to buy back the other one, as shown in the table below:

Purchase Date Sell Date Dividend
Dec. 31 Feb. 28  
Buy A Sell A $3
Mar. 1 Apr. 30  
Buy B Sell B $3
May 1 Jun. 30  
Buy A Sell A $3
Jul. 1 Aug. 31  
Buy B Sell B $3
Sep. 1 Oct. 31  
Buy A Sell A $3
Nov. 1 Dec. 31  
Buy B Sell B $3
  Total $18

Remember: While this strategy can boost already impressive yields, it’s not risk-free. Funds using this approach were beaten up badly in the market downturn. Pay close attention to the overall market and the stock’s underlying fundamentals. With the market pulling back the past few days, this may be an opportune time to lock in higher yields. With the dividend-capture strategy, your effective yield will be even higher.

P.S. Want to learn more about the dividend-capture strategy? Click here.