Do people actually earn interest on shares of dividend-paying stocks? They do, and many investors who put their money exclusively into corporations that pay regular (usually quarterly) dividends can make a double killing if they take the time to select excellent, blue-chip stocks that not only pay dividends but also increase in price.
What do you need to know in order to maximize your returns with this strategy? First, learn how to calculate compound interest on just the dividend, assuming there’s no change in the share price. Next, identify corporations that demonstrate consistent payout histories, the so-called “dividend aristocrats.”
Also, be sure to screen companies for long-term stability and use a brokerage firm that allows you to automate the reinvestment of all dividends. Finally, aim for at least a decade-long window for growing your investments to assure a worthwhile return.
Here are the details of how to execute each step of the dividend reinvestment system.
Calculate Interest from Dividend-Paying Stocks
It’s easy enough to use a compound interest calculator to find out how well you’d do, assuming the stock price didn’t change at all. But the big caveat here is that share prices can and do change, especially over a 10-year time frame.
Here’s an example. Suppose ABC Corp. pays a quarterly dividend to all its shareholders in an amount that is equal to a four percent annual rate. Of course, that means the quarterly rate is one percent, but we don’t need to know that to use the calculator.
Simply plug the key values into the calculator to determine how much you’ll earn in interest over a given period. For example, assume you place $5,000 into ABC’s shares initially, earn four percent annually, but receive interest on a quarterly basis. How much do you have at the end of 10 years?
Placing those values into the calculator and remembering to select “quarterly” under the category “compound frequency” and zero under “payment,” you’d have earned $2,444.32 in interest, which totals $7,444.32 when added to the principal investment.
Pick Companies With Consistent Payout Histories
You can do research on any company to find out how consistently it pays out dividends. The “aristocrats” are corporations who have not missed a quarterly payout in at least 25 years, so most of the names you find when you search those lists are solidly reliable when it comes to paying shareholders every three months.
Keep in mind that interest rates vary widely, with some aristocrats paying just one or two percent annual yield while others pay as much as six or seven percent. Obviously, to maximize your earnings, strive to select companies that pay regularly and offer attractive interest rates.
Choose Shares That are Likely to Increase in Price
The other factor that affects what your accumulated earnings will be is the share price. Dividends are calculated on the price of shares. So, if company ABC’s stock is worth $100 per share and they pay a four percent annual dividend, you would receive one percent quarterly interest on the then-current share price.
When prices rise, so do total amounts paid in dividends, even though the dividend percentage doesn’t change at all. So if you’re lucky enough to choose aristocrats with high interest rates and whose shares increase in value during your time frame, your earnings could be quite high.
Think in Terms of Decades, Not Years
Because you want the “power of compounding” to work in your favor, place as much as you can afford into the account when you open it. That way, the amount will earn interest from day one. Next, consider adding incremental amounts whenever you can.
For example, many people open with a balance of several thousand dollars and continue to budget a monthly add-in for the remainder of the time period. Of course, this adds to the grand total at the end of the 10-year (or whatever length) period, but you won’t get ten years’ worth of interest on all the deposits.
Use a Broker Who Automatically Reinvests the Dividends
Use a broker who has low fees. Many charge nothing or only a nominal amount for dividend reinvesting. Make sure your account is set up for auto-reinvesting of all dividends. You don’t want to take any payouts if your goal is long-term accumulation. It’s also wise to work with a brokerage firm that allows for ownership of fractional shares.
So, anyone who wants to earn a solid interest rate on the so-called “dividend aristocrats” should choose carefully. Look for companies that not only pay attractive interest rates but are also stable and have a reliable history of increasing in share price over the long run.