Income Investing with Dividend Paying Stocks

Income investing has a very broad definition and means different things to different people. 

Fixed income investment, for example, typically means some sort of debt instrument that pays a certain amount of interest until its maturity date. Government and corporate bonds are usually the go-to for that style of income investing. 

This article is not about fixed income or bonds. It’s about generating income in the form of dividends from stocks and exchange traded funds (ETFs). 

Income Investing with Dividend Paying Stocks

With the traditional 60/40 portfolio of stocks and bonds out the window, and more people managing their own retirement accounts, it’s more important than ever to have a solid base of income-paying stocks and funds that you can use to create a long-term portfolio that will pay you in retirement. 

This article will cover:

  • Why Dividend Paying Stocks Are So Powerful
  • Different Kinds of Stocks That Pay Dividends
  • How to Set Up a Dividend Reinvestment Plan
  • The Best Stocks That Pay Monthly and Quarterly Dividends
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Creating Wealth with Dividends: The Rule of 72

One of the most powerful investment secrets on Wall Street is using the Rule of 72 to generate long-term wealth with income investments.

The secret to this approach is the compounding effect that Albert Einstein once called “the most powerful force on earth.”

It’s so powerful that you rarely hear about it because financial advisors would be out of the job if everyone did it on their own. 

The Rule of 72 says that in order to find the number of years it takes for you to double your investment at a given rate, just divide the yield into 72.

For example: If you are earning a 6% dividend on your investment, it takes 12 years to double your money (72 divided by 6), or 19 years to triple it (72 times 2, divided by 6).

The compounding effect arises when your dividend yield is added to the principal — called dividend reinvestment — so that from that moment on, the interest begins to earn interest on itself. You can do this manually by buying more shares with the dividend income you receive, or you can automate it with a dividend reinvestment plan (DRIP).

Here’s an example using Altria (NYSE: MO), a well-known dividend-paying stock that owns major tobacco brands. 

Over the past 20 years, a $10,000 investment in Altria with dividends reinvested would have turned into $134,805 for a total return of 1,248%. Meanwhile, a $10,000 investment over the same time in the S&P would have turned into $49,741, for a total return of only 397%.

Altria investment example.

The compounding interest income coupled with the underlying capital appreciation of the stock means the difference between hundreds and thousands of percent return over time. 

Setting Up a Dividend Reinvestment Plan (DRIP)

There are a couple ways to set up a dividend reinvestment plan to harness this type of income. 

The easiest that I’ve seen is brokers that offer this option right when you buy stock. I use Schwab, and there is a button you can check on the trade screen that says “Reinvest Dividends.”

Reinvest Dividends.

Just click this button when buying a dividend-paying stock and you’re all set. 

Alternatively, some companies offer direct stock purchase plans, in which you become a registered shareholder and buy stock directly from the company. This is typically administered by a transfer agent, where you have to create an account. Altria (NYSE: MO), for example, uses Computershare to do this. Many other companies do, too. 

Direct stock purchase plans,

If a company offers a program, you can usually find info about it on the “investors” section of their website. 

Each company’s plan is different. Some have minimums and fees, and some have no fees at all. Some offer discounts to the stock price when directly repurchasing, and some don’t.

When I do it though my broker I pay no fees, so I always try that way first. 

Some of the top companies for DRIPS include:

  • Abbott Laboratories (NYSE: ABT)
  • Albemarle Corp. (NYSE: ALB)
  • Hormel Foods (NYSE: HRL)
  • Johson & Johnson (NYSE: JNJ)

Just because a company pays a dividend now, doesn’t mean it’s a great candidate for a long-term DRIP. Not all dividend paying stocks are created equal. 

Top Dividend Stocks: The Aristocrats

When a company in the S&P 500 has been consistently paying and annually increasing its dividend for a quarter century or more it is considered a dividend aristocrat. 

These are safest, highest quality dividend stocks you can buy, making them appropriate for constructing your own individual retirement account (IRA) or a child’s 529 college fund. 

As of this writing there were 65 such stocks. 

Some people prefer the relative safety of the largest companies in this group with market caps in the hundreds of billions. While market capitalizations are fluctuating all the time, as of this writing the ten largest dividend aristocrat stocks are:

  • Johnson & Johnson (NYSE: JNJ)
  • ExxonMobil (NYSE:: XOM)
  • Walmart (NYSE: WMT)
  • Chevron (NYSE: CVX)    
  • Procter & Gamble (NYSE: PG)    
  • AbbVie (NASDAQ: ABBV)
  • Coca-Cola (NYSE: KO)
  • PepsiCo (NYSE: PEP)
  • McDonald’s (NYSE: MCD)
  • Abbott Labs (NYSE: ABT)

Another way to look at these stocks is by how high their yield is. The dividend aristocrats with the highest yield are:

  • Realty Income (NYSE: O)
  • 3M (NYSE: MMM)
  • Walgreens (NASDAQ: WBA)
  • Franklin Resources (NYSE: BEN)
  • Essex Property (NYSE: ESS)
  • Amcor (NYSE: AMCR)
  • Stanley Black & Decker (NYSE: SWK)
  • Federal Realty (NYSE: FRT)

Stocks That Pay Monthly Dividends

Some stocks pay monthly dividends. And that can entice investors who are looking for more frequent payouts since you get 12 payments annually instead of the 4 you’d get with companies that pay quarterly. 

However, these stocks can be much smaller and therefore more risky than their quarterly-paying counterparts. They can also be in sectors that are more subject to booming and busting — like energy and real estate — than in traditionally more consistent sectors like consumer staples and healthcare. Note also that these dividends may not be sustainable based on the fundamentals of the company and can be slashed or suspended with little notice. So make sure you’ve really done your homework if you choose to pursue companies that pay monthly dividends. 

As of this writing the highest paying monthly dividend stocks were:

  • Permianville Royalty Trust (NYSE: PVL)
  • Ellington Financial (NYSE: EFC)
  • Oxford Square Capital (NASDAQ: OXSQ)
  • Ellington Residential Mortgage REIT (NYSE: EARN)
  • AGNC Investment Corporation (NASDAQ: AGNC)
  • PermRock Royalty Trust (NYSE: PRT)
  • San Juan Basin Royalty Trust (NYSE: SJT)
  • Orchid Island Capital (NYSE: ORC)
  • ARMOUR Residential REIT (NYSE: ARR)
  • Broadmark Realty Capital (NASDAQ: BRMK)

Real Estate Investment Income    

You don’t have to buy a rental unit to generate real estate investment income. You can generate real estate investment income from the stock market as well. This is typically done through a real estate investment trust (REIT). 

Typically, these trusts focus on particular areas of the real estate market. And that can allow you to get really granular when you select them. 

For example, with the ‘work from home’ movement in full swing, it might not be the best idea to invest in a REIT that owns corporate buildings or office space. Conversely, with the cannabis sector due for a rebound you might check out a REIT that owns marijuana grow or storage space. 

These are just two examples. There are REITs for every corner of the market. There are medical REITs, storage space REITs, commercial and residential REITS, low income housing REITs, retail and mall REITs, and more. You can even buy cell tower REITs and data records management REITs. Here are the REITs that consistently have the largest market caps:

  • Annaly Capital Management (NYSE: NLY)
  • AGNC Investment Corp (NASDAQ: AGNC)
  • Prologis (NYSE: PLD)
  • American Tower Corporation (NYSE: AMT)    
  • Crown Castle International (NYSE: CCI)
  • VICI Properties (NYSE: VICI)
  • Welltower Inc (NYSE: WELL)
  • Digital Realty Trust (NYSE: DLR)
  • Simon Property Group (NYSE: SPG)
  • Alexandria Real Estate Equities (NYSE: ARE)

A Real World Dividend Income Investing Example

In a well-constructed long-term stock portfolio you likely wouldn’t have any single position larger than 6%. 

That means you could have 16 or 17 stocks at maximum positioning, or many more if they take up less than that 6% maximum. 

Of course, that implies that 100% of your portfolio is in stocks. In most cases, that shouldn’t be the case because you should also own currencies, commodities, and other asset classes based on your age and risk tolerance. 

As of this writing, I own 14 dividend paying stocks. None of them take up more than 2.5% of my portfolio. 

And I own them based on what’s going on in the broader market. 

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We have been in a bear market with recession fears for a year now, so I own more traditionally defensive sectors like consumer staples, utilities, and precious metal mining stocks. 

And I will rotate or rebalance my positions based on ever-changing market cycles. 

Some people like to “set it and forget it.” That means you’re a passive investor. If that’s you, then you should own equal positions in all 11 of the S&P’s sectors and rebalance them quarterly. For reference, those sectors are:

  1. Communication Services
  2. Consumer Discretionary
  3. Consumer Staples
  4. Energy
  5. Financials
  6. Health Care
  7. Industrials
  8. Information Technology
  9. Materials
  10. Real Estate
  11. Utilities

You could own a large stock in each of those sectors or you could use a sector ETF. State Street Global Advisors offers a series of funds called S&P Depository Receipts (SPDRs, pronounced: spiders) that make tracking those sectors very straightforward: 

  1. Communication Services Select Sector SPDR Fund (NYSE: XLC)
  2. Consumer Discretionary Select Sector SPDR Fund (NYSE: XLY)
  3. The Consumer Staples Select Sector SPDR Fund (NYSE: XLP)
  4. Energy Select Sector SPDR Fund (NYSE: XLE)
  5. Financial Select Sector SPDR Fund (NYSE: XLF)
  6. Health Care Select Sector SPDR Fund (NYSE: XLV)
  7. Industrial Select Sector SPDR Fund (NYSE: XLI)
  8. Materials Select Sector SPDR Fund (NYSE: XLB)
  9. Real Estate Select Sector SPDR Fund (NYSE: XLRE)
  10. Technology Select Sector SPDR Fund (NYSE: XLK)
  11. Utilities Select Sector SPDR Fund (NYSE: XLU)

You can of course get much more granular by using sub-sector funds or individual stocks. As an active investor, that’s what I do. 

I use a blend of funds and individual stocks to create the dividend-paying portion of my portfolio. And I don’t own all the sectors at any given time. 

Technology stocks, for example, were terrible investments in 2022, with the above mentioned Technology Select Sector SPDR Fund losing 30% of its value. So I didn’t own it, instead opting for consumer staples and utilities as previously mentioned — both of which far outperformed the technology sector. 

So you need to decide what type of investor you are, what your risk tolerance is, and how often you want to touch your portfolio. 

I have been able to beat the S&P for seven out of the past eight years with the strategies I publish in a monthly service called Foundational Profits. Every month I go through my current allocations, explain what I’m buying and selling, and why I’m doing it. 

If you’d like assistance in constructing a quality long-term portfolio that includes dividend stocks, you can check out the latest issue of Foundational Profits here.

Nick Hodge

Nick Hodge
Publisher, Daily Profit Cycle