Recently, I investigated installing solar panels on my roof to reduce my monthly energy bills.
The financial calculations are fairly involved. There is the cost of the panels, the additional cost to my homeowners insurance, a utility company rebate, a federal tax break, the cost of the energy I use and the cost of the energy I produce that I could sell back to the utility company.
It was just about the time that I was inundated with estimates when I received this email from a reader of my premium dividend advisory, The Daily Paycheck:
"Your newsletter is my favorite of all I receive. I have been concentrating on a portfolio of monthly dividend payers only to maximize monthly income. I have concentrated with those funds that pay a minimum of 7% or better. What are the pro and cons of this and what can I do to improve the strategy? (I'm addicted to monthly paychecks!)"
-- Thanks, Dave E., Escondido, Calif.
Dave's email reminded me that one of the best ways to tackle monthly bills -- is with monthly dividends.
Why Dividend Frequency Matters
When considering a new security, income investors search out its yield and investigate whether it can maintain its dividend. But more often than not, dividend frequency is overlooked.
On one hand, I understand the omission. After all, if a security pays an annual dividend of $1.20 per share, what difference does it make is it pays $1.20 per share once a year or $0.10 per share 12 times a year?
All else being equal, however, a more frequent dividend payer is better than a less frequent dividend payer. This is especially true if you reinvest dividends.
1. The Higher the Frequency, the Faster the Growth
If you reinvest your dividends as I do, you will ultimately make more money with a monthly dividend payer than an annual dividend payer.
In the chart below, I have compared the growth of $100,000 invested in securities yielding 7%. In one case the security makes monthly distributions and in the other case it makes an annual distribution. In both cases, dividends are reinvested. And for simplicity, I've assumed that the securities neither appreciate nor depreciate over time.
Initially there isn't much difference between the two positions. After the first year, the monthly payer has a slight edge, valued at $107,229 versus the $107,000 value of the annual payer. But as time goes on, the difference widens. After 10 years, the monthly payer is worth $4,251 more.
The sooner you reinvest a dividend, the more time it has to generate compound growth.
2. Less Market Risk
With an annual distribution, you have one day a year to buy additional shares via a dividend reinvestment program. But what if the stock hits an all-time high price on that day? You could get unlucky and reinvest in shares at a high price -- and a low yield.
With a monthly dividend, you reinvest in shares 12 times a year, spreading out the market risk of your reinvested dividends.
3. Easier Decisions
When I buy dividend-paying stocks, I intend to hold them for the long haul. But sometimes the unexpected happens. Maybe market conditions get too risky for a specific asset class. Maybe a company runs into trouble. Or maybe I suddenly need the cash for a personal emergency.
But what if the stock I need to sell has a pending annual dividend? I'd hate to hold on to a stock for 11 months, only to have to sell it right before its payoff. I'd also hate to hold on to a problem stock just for its dividend. I don't want to lose $2 in share price just to collect $1 in dividends.
Investing decisions are hard enough. I don't need to make them any more difficult. The more frequent the dividend, the less an impact distributions have on my buy and sell decisions.
I use the "Daily Paycheck" strategy (which I talked about in a recent issue of StreetAuthority Daily) in my personal portfolio. As a Baby Boomer, I'm at the age where I need to continue to grow my retirement fund, and dividend reinvestment is a great growth engine. But in time, I'll need to rely on my portfolio for the income it generates.
Although I am getting closer to paying off my mortgage, there may be a couple of years when I will use my retirement income to pay my monthly mortgage bill. I will use it to pay my monthly electric bill, my monthly cable bill, my monthly phone bill. Monthly dividends are just a little more convenient when it comes to paying monthly bills.
For instance, in my Daily Paycheck portfolio, I've spent $5,582.12 on shares of Reaves Utility Income Fund (NYSE: UTG) -- not including the shares I've bought through dividend reinvestment. In roughly four years' time my total shares of UTG pay out roughly $46 a month in dividends. Of course, that's probably not quite enough to cover your monthly utility bills. But give it a few more years of dividend reinvestment and it just might.
More Monthly Payers -- Fewer Timely Choices
There are hundreds of monthly dividend-paying securities, with more launching every day. Unfortunately, the vast majority of monthly dividend payers are fixed-income securities. The prices of fixed-income investments are interest-rate sensitive. And since U.S. interest rates are liable to rise over the next twelve months, it is probably not the best time to add a fixed-income security.
I'm not suggesting that investors toss out the funds they love. But in general, I wouldn't want anyone to have too many fixed-income eggs in their baskets.
Equity monthly payers are a better option, but they are few and far between. For instance, of the 190 exchange-traded funds (ETFs) that pay monthly, only 14 are classified as equity funds. Roughly the same percentage applies to the nearly 700 monthly dividend-paying closed-end funds.
Put simply, good monthly dividend-paying equity securities may be hard to find. But they are out there. As I mentioned earlier, Reaves Utility Income Fund, which yields 6.1%, is a good one to start.
And because the goal of my "Daily Paycheck" income strategy requires a minimum of 30 dividend checks a month, I try to hold several monthly dividend payers in my portfolio. As a nice bonus, many of these carry annual dividend yields of 7.1%, 8.3%, or even 9.7%.
The strategy is working. Since I started my Daily Paycheck portfolio back in December 2009, my initial $200,000 investment grew to more than $300,000 by 2013, giving me a total return of more than 50% in just four years. Even better, the dividend payments I received from my portfolio in 2013 averaged about $1,353 per month.
If you'd like to learn how to start your own Daily Paycheck portfolio -- and get a few high-yield, monthly dividend stock picks while you're at it -- I invite you to read this short memo.
This article was originally published by StreetAuthority under the title: Four Reasons I Love Monthly Dividend Payers... And You Should, Too