Investing in income stocks for dividends - worth it?

Question

I currently have a 401k that I'm maxing out for this year ($18,000) and a Roth IRA that I'm maxing out ($5,500). I'm a bit behind on investments, but because of my income I think that I can play a bit of catch up in this year and hopefully the next year as well.

I have extra income that isn't going to either of those investments. Originally, I'd wanted to try to save enough for a down payment on a house, but after doing some thinking, I'm not sure if that's the wisest investment at this time in my life. (Buying a house would be an emotional decision - I want a space that is mine, and I don't want to throw away my money renting something that I want to be my home but isn't, if that makes sense.)

So I'm thinking. Because my 401k is a retirement plan (auto-balancing over the life of the investment) and the IRA is a similar setup, I'm thinking that I'd like to invest in income stocks to bolster my monthly income over time. I'm thinking I want to do this because I don't want to be actively trading stocks - but I also don't want to pay any management fees to have someone do that for me. Capital gains are only great if you sell the stock.

However....is it worth it? The average yield on a stock is, from what I read, 2-3% (in an index, S&P 500 I believe). As such, in order to even break the $20,000 annual income mark, I'd literally have to have one million dollars in income stocks. Because dividends are taxed like income, I'd have to have even more than that to turn a monthly profit. If I were to invest $2000 to $3000 per month into income stocks...it'd take forever.

Is my thinking correct, here? I'd like to try to break into dividend growth funds, but I'm worried that the dividends may not pay for themselves, even accounting for the growth factor. However, I think that this might be a good way to diversify as my retirement funds are heavily based upon capital gains (as they're long-term investments), and I think that being able to live on dividends instead of selling stock shares is probably a good way to build future wealth (especially if I spawn another generation).

Note that I'm a newbie to personal investing. Is dividend investing worth it?

Answer 1

After looking at your profile, I see your age...28. Still a baby. At your age, and given your profession, there really is no need to build investment income. You are still working and should be working for many years. If I was you, I'd be looking to do a few different things:

1. Eliminate debt if you have any.
2. Saving for a home.
3. If you want a second job, building a rental income portfolio.
4. Building your after tax investment portfolio.

Eliminating debt reduces risk, and also reduces the need for future income.

Saving for, and purchasing a home essentially freezes rent increases. If home prices double in your area, in theory, so should rent prices. If you own a home you might see some increases in taxes and insurance rates, but they are minor in comparison. This also reduces the need for future income.

Owning real estate is a great way to build residual income, however, there is a lot of risk and even if you employ a management company there is a lot more hands on work and risk.

Easier then that you can build an after tax investment portfolio. You can start off with mutual funds for diversification purposes and only after you have built a sizable portfolio should (if ever) make the transition to individual stocks.

Some people might suggest DRIPs, but given the rate at which you are investing I would suggest the pain of such accounts is more hassle then it is worth.

Answer 2

To answer your question: yes, it's often "worth it" to have investments that produce income. Do a Google search for "income vs growth investing" and you'll get a sense for two different approaches to investing in equities.

In a nutshell: "growth" stocks (think Netflix, etc) don't pay dividends but are poised to appreciate in price more than "income" stocks (think banks, utilities, etc) that tend to have less volatile prices but pay a consistent dividend.

In the long run (decades), growth stocks tend to outperform income stocks. That's why younger investors tend to pick growth stocks while those closer to retirement tend to stick with more stable income-producing portfolio.

But there's nothing wrong with a mixed approach, either. I agree with Pete's answer, too.

Answer 3

As a general rule of thumb, age and resiliency of your profession (in terms of high and stable wages) in most cases imply that you have the ABILITY to accept higher than average level of risk by investing in stocks (rather than bonds) in search for capital appreciation (rather than income), simply because you have more time to offset any losses, should you have any, and make capital gains. Dividend yield is mostly sough after by people at or near retirement who need to have some cash inflows but cannot accept high risk of equity investments (hence low risk dividend stocks and greater allocation to bonds).

Since you accept passive investment approach, you could consider investing in Target Date Funds (TDFs), which re-allocate assets (roughly, from higher- to lower-risk) gradually as the fund approaches it target, which for you could be your retirement age, or even beyond.

Also, why are you so hesitant to consider taking professional advice from a financial adviser?

Answer 4

is it worth it?

You state the average yield on a stock as 2-3%, but seem to have come up with this by looking at the yield of an S&P500 index. Not every stock in that index is paying a dividend and many of them that are paying have such a low yield that a dividend investor would not even consider them. Unless you plan to buy the index itself, you are distorting the possible income by averaging in all these "duds".

You are also assuming your income is directly proportional to the amount of yield you could buy right now. But that's a false measure because you are talking about building up your investment by contributing $2k-$3k/month. No matter what asset you choose to invest in, it's going to take some time to build up to asset(s) producing $20k/year income at that rate. Investments today will have time in market to grow in multiple ways.

Given you have some time, immediate yield is not what you should be measuring dividends, or other investments, on in my opinion. Income investors usually focus on YOC (Yield On Cost), a measure of income to be received this year based on the purchase price of the asset producing that income. If you do go with dividend investing AND your investments grow the dividends themselves on a regular basis, it's not unheard of for YOC to be north of 6% in 10 years. The same can be true of rental property given that rents can rise.

Achieving that with dividends has alot to do with picking the right companies, but you've said you are not opposed to working hard to invest correctly, so I assume researching and teaching yourself how to lower the risk of picking the wrong companies isn't something you'd be opposed to.

I know more about dividend growth investing than I do property investing, so I can only provide an example of a dividend growth entry strategy: Many dividend growth investors have goals of not entering a new position unless the current yield is over 3%, and only then when the company has a long, consistent, track record of growing EPS and dividends at a good rate, a low debt/cashflow ratio to reduce risk of dividend cuts, and a good moat to preserve competitiveness of the company relative to its peers. (Amongst many other possible measures.) They then buy only on dips, or downtrends, where the price causes a higher yield and lower than normal P/E at the same time that they have faith that they've valued the company correctly for a 3+ year, or longer, hold time.

There are those who self-report that they've managed to build up a $20k+ dividend payment portfolio in less than 10 years. Check out Dividend Growth Investor's blog for an example. There's a whole world of Dividend Growth Investing strategies and writings out there and the commenters on his blog will lead to links for many of them.

I want to point out that income is not just for those who are old. Some people planned, and have achieved, the ability to retire young purely because they've built up an income portfolio that covers their expenses. Assuming you want that, the question is whether stock assets that pay dividends is the type of investment process that resonates with you, or if something else fits you better.

I believe the OP says they'd prefer long hold times, with few activities once the investment decisions are made, and isn't dissuaded by significant work to identify his investments. Both real estate and stocks fit the latter, but the subtypes of dividend growth stocks and hands-off property investing (which I assume means paying for a property manager) are a better fit for the former. In my opinion, the biggest additional factor differentiating these two is liquidity concerns. Post-tax stock accounts are going to be much easier to turn into emergency cash than a real estate portfolio. Whether that's an important factor depends on personal situation though.