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I will be leaving my place of employment in the near future to run and grow my small business full-time. After assessing my expenses I'm expecting to be in the red $300-$400 a month for the next 1-2 years. Personally, I'd rather not see my net income every month as negative so I'm considering investing in some dividend paying stocks to supplement my income for the next 1-3 years.

I have $50k~ I'd feel comfortable investing that is currently sitting in a standard savings account. I plan to spread this out over a few dependable high dividend yielding stocks, but for this example I'll be using AT&T. As of this post AT&T is valued at $34.29 a share with a quarterly dividend of 0.47. Doing some quick math that would leave me with 1,458 shares averaging $228 a month in dividend payments before taxes. This would ease some of my concern with not generating a positive income for the next few years.

To answer some of your questions, I'm 26 years old, I have zero debt, 80k~ in a standard savings account, 25k~ in a 401k, 15K~ in stock, and I do not own a home.

My question is, what are some of the risks associated with investing in dividend paying stocks solely to supplement my income for the next 1-3 years, besides the usual risks of entering the stock market? Are there any investment alternatives I should be considering that would generate a similar monthly/yearly income? Am I just going about this all wrong?

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    I just wanted to say awesome job. 26 years old and you tucked away 80k – JonH Jul 25 '15 at 18:13
  • You should be indifferent between dividends and capital gains (actually, you should prefer capital gains because they're taxed lower and can be deferred). You are young and have a lot of cash. If you have a long time horizon, you should consider making your portfolio riskier. – Powers Jul 26 '15 at 0:38
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Your back of the envelope calculation shows an income of about 5.5% per year, which is much better than a bank. The risk of course is that in a few years when you want to sell the stock, the price may not be at the level you want.

The question is what are you giving up with this plan. You have 80K in cash, will cutting it to 30K in cash make it harder for your business to survive? If your income from the business starts slowly, having that 50K in cash may be better. Selling the stock when the business is desperate for money may lock in losses.

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I wouldn't focus too much on dividends itself; at the end of the day what matters is total gain, because you can convert capital gain into income by selling your assets (they have different tax implications, but generally capital gains tend to be more tax efficient).

I think the more important question is how much volatility you can tolerate. Since your investment horizon is short & your risk tolerance is low (as in if you suddenly get much lower income than you planned from your investment you'll be in trouble), you probably want assets that have low volatility.

To achieve that, I'd consider the following if I were you:

  • Use a large cap high-dividend yield ETF instead of a few individual stocks for better diversification. Or even just a broad total world equity ETF like VT.
  • Combine it with other asset class like bonds, REITs
  • Combine it with quasi risk-free assets like savings account (shop around and you may find something better than what you have now)
  • Consider adding P2P lending to the portfolio. A lot of services have a yield of 5-7% after fee/bad debt.

tl;dr
If I were you I'd just hold a general investment portfolio with a lower risk profile rather than focusing on dividend generating assets.

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    Huh, weird I got the same amount of upvotes and downvotes! Wish downvoters cared to explain. I'm just saying there's no need to buy high-dividend stocks just because you plan to consume. By doing that you'll be taking a position against the market, which you should avoid if you are not an expert. Different companies generate returns in different ways, and money is money; if it's through capital gain, you can just sell part of your assets to get the monthly income you need if dividends don't suffice. – Enno Shioji Jul 26 '15 at 8:31
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    What If you pick stocks that don't generate dividends, and hope that they have gains every month so you can sell them; but the market doesn't perform a expected? Now you are selling at a loss to generate the money that is needed. – mhoran_psprep Jul 26 '15 at 11:02
  • @mhoran_psprep: it may feel different, but other than the tax implication there really is no difference. The only difference is whether the loss is realised or unrealised. If the market doesn't perform, the dividend stocks would also lose value. The only difference between realised loss and unrealised loss is tax implication. – Enno Shioji Jul 26 '15 at 11:36
  • @mhoran_psprep: Ah, found an article that talks about this: forbes.com/sites/billharris/2012/09/26/… – Enno Shioji Jul 26 '15 at 12:37
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    @EnnoShioji, so by selling part of your stocks each month to derive income you will end up with no capital in your account and you will be spending quite a bit in commissions. This is actually not deriving an income from your investments, it is selling down your investment which is quite different, because the stocks will have to keep increasing every month for you to be successful in this strategy. – user9822 Jul 26 '15 at 21:16
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Usually when a company is performing well both its share price and its dividends will increase over the medium to long term. Similarly, if the company is performing badly both the share price and dividends will fall over time.

If you want to invest in higher dividend stocks over the medium term, you should look for companies that are performing well fundamentally and technically. Choose companies that are increasing earnings and dividends year after year and with earnings per share greater than dividends per share. Choose companies with share prices increasing over time (uptrending).

Then once you have purchased your portfolio of high dividend stocks place a trailing stop loss on them. For a timeframe of 1 to 3 years I would choose a trailing stop loss of 20%. This means that if the share price continues going up you keep benefiting from the dividends and increasing share price, but if the share price drops by 20% below the recent high, then you get automatically taken out of that stock, leaving your emotions out of it.

This will ensure your capital is protected over your investment timeframe and that you will profit from both capital growth and rising dividends from your portfolio.

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