Dividend Stocks II

It may take a little time
A lonely path, an uphill climb
Success or failure will not alter it
--Howard Jones

Previously we examined some of the major benefits and risks associated with dividend-paying stocks. Today we'll consider the implications of building dividend-paying stock portfolios for investors both young and old.

While it is common for investors to focus on capital gains possible from equity investments, studies suggest that roughly half of the returns from stocks are due to dividend payouts. Stated differently, investment strategies centered on dividends tend to be under-appreciated--and perhaps undervalued--by investors.

To see why this might be true, let's focus on the income-producing potential of dividend stocks. Although the annual dividend yield on the S&P 500 currently stands at about 1.9%, it is possible to build a diversified basket of solid dividend paying stocks that yield 3% or more. Consider, for example, the following list of stocks:

Cisco Systems Inc (CSCO) 2.5% annual yield
Dominion Energy Inc (D) 4.8%
General Mills Inc (GIS) 3.8%
Johnson & Johnson (JNJ) 2.7%
Coca-Cola Co (KO) 3.5%
Target Corp (TGT) 3.2%
Wells Fargo & Co (WFC) 3.7%
Exxon Corp (XOM) 4.0%

A portfolio invested in equal dollar amounts of these securities would currently yield a collective 3.5%. For every $1,000 in portfolio value of the above design, that's $35 in annual income. That may not seem like much, but keep adding zeros to those payouts for larger portfolios. For a $10,000 portfolio, cash payouts amount to $350 annually. For a $100,000 portfolio, $3,500 annually. For $1,000,000, the investor collects $35,000 each year at current yields.

Keep in mind that companies maintaining strong competitive positions in their industries are likely to increase their dividend payments over time. Should the above basket of dividend payers increase its payouts by 5% each year for the next 15 years, then the yield on the basket would double to 7%. You can do the math on how much that would increase annual dividend income on the various portfolio sizes mentioned above.

As noted last time, there is also the potential for share price appreciation among dividend stocks that sweetens the story even more. Personally, however, I like to view that sweetener as icing on the cake that I don't plan to eat. I like to own dividend paying stocks for their income producing potential over a lifetime. While capital gains are nice, I don't plan to sell these income producers (absent a substantial decline in their business fundamentals) because, to mix metaphors here, that would be like selling the goose that lays the golden eggs. If I sell the dividend-paying geese, then no more income eggs.

There are implications here for young and old alike. If you are a younger investor, then dividend income supplements the regular income earned from your everyday job. By taking some of your regular income and investing it in the production processes of others, you acquire additional income that essentially makes you more productive--and diversified--over time. A goal to consider: acquire as large a supplemental income stream from dividends that you can reasonably afford, and let it build over time. When you are a young, dedicated investor, the miracle of compounding works wonders for building wealth as you age.

If you are an older investor, then dividend-paying stocks offer an income replacement when your retire. Retirement essentially amounts to voluntary unemployment. Income from work disappears. Resources to fund retirement lifestyles typically come from pensions, mandatory IRA and 401(k) withdrawals, and government transfer payments such as Social Security. Dividend-paying stocks offer an additional source of regular income for retirees. Referring back to the example offered above, every $100,000 invested in the list yields $3,500 in annual income--an income that is likely to grow greater than inflation over time. A goal to consider: develop a stable of dividend-paying stocks in a taxable brokerage account that builds passive income-producing capacity for retirement. The more dividend payers that you acquire, the greater the income replacement coming from this source for retirement. This is where I am currently.

Finally, for both young and old, consider this. Capital invested in dividend-paying stocks should be patient. Don't buy dividend stocks to sell them. Buy them for keeps. Once your are done benefiting from your investment, pass it along to the next generation, and suggest that it does the same.

positions in CSCO, D, GIS, JNJ, KO, TGT, WFC, XOM