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Carla Pasternak's picture

Wednesday, May 29, 2013 - 10:00am

by Carla Pasternak

A traditional "dividend capture" strategy is pretty simple, and if done correctly, it can be an easy way to dramatically increase the dividend yields on your existing dividend-payers. In my experience, it can make an already attractive high-yield stock even more attractive.

It works like this: 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 just one problem with the traditional strategy, 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. 

Fortunately, there's a better way to execute this strategy...

While there is no surefire way to mitigate the entire risk of the dividend-capture strategy, investors can alleviate some of it 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 10% dividend yield. Each stock delivers a total annual payment of $10 a share; that equates to a dividend payment of $2.50 a share each quarter. 

By rotating in and out of the two stocks, you can capture six tax-advantaged quarterly dividends instead of four (that's 50% more dividend payments) each year, or $15 a share instead of $10. In other words, you can increase your yield from 10% to 15% 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 $2.50 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 $2.50 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 $2.50
Mar. 1 Apr. 30
Buy B Sell B $2.50
May 1 Jun. 30
Buy A Sell A $2.50
Jul. 1 Aug. 31
Buy B Sell B $2.50
Sep. 1 Oct. 31
Buy A Sell A $2.50
Nov. 1 Dec. 31
Buy B Sell B $2.50

Total $15

 

Remember: While this strategy can boost already impressive yields, it's not risk-free. There's no guarantee that the extra income will cover any falls in the share price.

That said, using a dividend capture strategy is one of the simplest ways you can boost your income stream throughout the year. 

Action to Take --> Pay close attention to the overall market and the stock's underlying fundamentals before you buy. When a pullback comes in the future, it could be the perfect opportunity to pick up great dividend payers at a discount. And with this dividend-capture strategy, your effective yield will be even higher.

P.S. -- If you're tired of settling for sub-par yields, then advanced strategies like dividend capture may be exactly what you need. My friend Elliott Gue recently launched a brand-new income advisory, High-Yield PRO, which is designed specifically for income investors looking to take their portfolios to the next level. To learn more about the strategies Elliott is using to deliver double-digit yield income to his readers, click here.

Carla Pasternak does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.