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Dividend Investing: Replacing Your Paycheck
As retirement nears, people have thoughts ranging from social concerns (What am I going to do all day?) to financial fears (How am I going to afford to live the life I want?). Making matters worse, many are at the same time making large life decisions, like choosing to move to a new state—going from the New York rat race to the beach bum life in southern Florida, for example. While those too young to consider retirement may think it’s easy street, the fact is that there’s a lot going on during the transition from work to retirement.
With a little planning, losing the regular paycheck doesn’t need to be one of the big issues. Dividends can reduce the impact of exiting the workforce and, with careful management, can provide a steady monthly flow of income.
Dividends are paid in several different ways. A few companies pay dividends only once a year, which makes financial planning kind of hard. Although not exactly stable, such payments could be looked at as a yearly “bonus”. Many foreign companies pay dividends twice a year, a better frequency for scheduling spending, but still problematic because of their infrequent nature. There is also the caveat that foreign companies often pay a small interim dividend followed by a much larger final dividend. Since most people have enough trouble managing their finances on a month to month basis, companies that pay twice a year still don’t cut it.
Most U.S. companies pay dividends quarterly. This is much more manageable for balancing costs versus expenses. Moreover, with a little patience, and perhaps a penchant for puzzles, you can create a portfolio in which you receive a dividend each month—consider this the paycheck replacement method. Using the Dow Jones Industrial Average as nothing more than a source of dividend payers, you could buy Caterpillar (CAT - Free Caterpillar Stock Report), AT&T (T - Free AT&T Stock Report), and 3M (MMM - Free 3M Stock Report).
Caterpillar-January, April, July, and October
AT&T-February, May, August, and November
3M-March, June, September, and December
Although the dividend income one would receive from these three companies is vastly different, owning shares in these three companies would result in a check every single month. The point of the example is merely to show that, with a little bit of planning, one can create a monthly dividend stream that mimics a paycheck—and do so with financially strong companies. Value Line subscribers will find the dividend schedule for each of the 1,700 companies in the Investment Survey listed in the Footnotes section of each company’s individual report.
There is also a small collection of companies that pay dividends monthly. This, clearly, simplifies the replacement of a paycheck, but the list of monthly dividend payers is quite small, so a great deal of care is needed in the selection process. Some of the companies that pay monthly dividends that Value Line covers in The Value Line Investment Survey include Realty Income Fund (O), Gladstone Capital (GLAD), Enerplus (ERF), and Pengrowth Energy (PGH). In the Small & Mid-Cap Survey, Value Line covers monthly dividend payers Atlantic Power (AT) and Gas Natural (EGAS). All of these companies are worth reviewing to see if they can help smooth out the ups and downs of the income stream inherent to a dividend portfolio.
There are also a significant number of closed-end funds that pay monthly dividends. Closed-end funds paying monthly can range from well diversified portfolios to highly focused, non-diversified offerings. This means that these funds can provide a base on which to build a dividend stream or add some spice to an otherwise diversified portfolio. However, there can be major disadvantages to owning closed-end funds.
For example, closed-end funds often employ aggressive tactics, including leverage and options techniques, to increase their dividend payouts. The dividends are often static, which means that capital growth will be needed to keep up with inflation. And closed-end funds trade on supply and demand, but still have a net asset value (like an open-end fund), which means that you could overpay for shares of a desirable closed-end fund unless you carefully watch the premium/discount of the shares. A great deal of care needs to be taken when considering closed-end funds. Value Line reviews a small collection of closed-end funds, many of which have long operating histories, which is a plus.
There are, literally, just a few open-end funds that pay monthly dividends. They tend to be highly focused on an asset class or investment approach. Both the open-end and closed-end variety of funds often distribute capital back to investors if dividend income or gains aren’t enough to support the monthly dividend. In other words, sometimes you are just getting back what you put in. This can be a material negative and should be closely monitored both before and after purchase. The Value Line Mutual Fund Survey provides research and Value Line’s proprietary Mutual Fund Ranks exist on close to every mutual fund available.
The take away should be that replacing the monthly paycheck isn’t impossible; it just takes a little planning. Focusing on dividend paying companies that have a history of increasing their payouts is clearly the best idea since it will allow you to maintain your purchasing power over time. Adding a company or fund that pays a static but high frequency dividend, however, can help with diversification and income stability. Throwing on some foreign companies that pay twice a year can create a “bonus” that can help pay for expected, but infrequent, expenses like trips or gifts for the grandkids.
It’s probably a good idea to start thinking about a dividend-focused paycheck at least a few years before you plan on retiring. This way, you won’t be trying to take on too much at one time. That said, creating a new paycheck isn’t nearly as hard as it seems.
At the time of this article’s writing, the author had positions in O and AT.