5 steps to make $500 a month in dividends

5 steps to make $500 a month in dividends

What is a monthly dividend portfolio?

A monthly dividend portfolio of carefully selected stocks, mutual funds, and other predictable investments that pay dividends. When curating your investments you’ll want to look at when they pay dividends so that you’ll receive them each month of the year.

There are different opinions on if this is a good investment strategy. Some people prefer different investing approaches. Ultimately you’ll need to decide if creating a monthly dividend portfolio fits with your financial goals and risk tolerance.

When selecting stocks and investments you need to remember that no dividend is 100% guaranteed to pay based on its past history, typically there’s a higher probability of the payment pattern to continue in the future.

Dividend-capture strategies

You may wonder if there is a way to capture only the dividend payment by purchasing the stock just prior to the ex-dividend date and selling on the ex-dividend date. The answer is “not quite.”

Remember that the stock price adjusts for the dividend payment. You buy 200 shares of stock at $24 per share on February 5, one day before the ex-dividend date of February 6, and you sell the stock at the close of February 6. The stock pays a quarterly dividend of $0.50 per share. The stock price will adjust downward on February 6 to reflect the $0.50 payment. It’s possible that, despite this adjustment, the stock could actually close on February 6 at a higher level. It is also possible that the stock price could close February 6 at a level lower than the $23.50 price suggested by the $0.50 adjustment to reflect the $0.50 dividend.

For the sake of this example, assume the stock adjusts perfectly and you sell at $23.50 per share. Are you better or worse off for capturing the dividend? You will receive $0.50 per share in the dividend, but you’ll lose $0.50 per share because of the decline in the stock price. It would appear to be a wash. But what about taxes? Aren’t dividends currently taxed at a maximum 15% rate? The answer is “yes,” but with a catch. In order to receive the preferred 15% tax rate on dividends, you must hold the stock for a minimum number of days. That minimum period is 61 days within the 121-day period surrounding the ex-dividend date. The 121-day period begins 60 days before the ex-dividend date. When counting the number of days, the day that the stock is disposed is counted, but not the day the stock is acquired.

If the stock is not held at least 61 days in the 121-day period surrounding the ex-dividend date, the dividend does not receive the favorable 15% rate and is taxed at your ordinary tax rate.

To recap your dividend capture strategy:

  1. You paid $4,800 (plus commission) to purchase 200 shares of stock.
  2. Because you bought before the ex-dividend date, you’re entitled to the dividend of $0.50 per share, or $100. But because you didn’t hold the stock for 61 days, you’ll pay taxes at your ordinary tax rate. Let’s assume you are in the 28% tax bracket. That means your take after taxes is $72.
  3. You sold 200 shares at $23.50 for $4,700, a loss of $100 (plus commissions). You now have a “realized” short-term loss, which you can offset against realized capital gains or, if you have no realized gains, up to $3,000 of ordinary income.

In this case, the dividend-capture strategy was not a winner. You’re out the commissions to buy and sell the shares, you have a realized loss that you may or may not be able to write off immediately (depending on the amount of realized gains and losses you already have), and you lose the preferred 15% tax rate on your dividends because you didn’t hold the stock long enough.

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How do dividends work?

If you own stocks of companies that pay a dividend, you can receive a dividend payment. However, it’s important to note that not all companies offer dividends. As long as the company commits to paying a dividend continuously, you’ll receive dividends every year. An ordinary dividend refers to a regularly scheduled payment made by a company to its shareholders.

Here’s how it works: Let’s say you buy 200 shares of a company for a share price of $5 each — that’s a total of $1,000 invested. Each share pays you $0.50 in dividends quarterly. You’d get $400 in dividend payments over one year.

You can do what you want with your dividend returns, such as reinvest them back into more shares, or you can spend or save the money you receive.

How to Build a Portfolio that will Make $1,000 per Month in Dividends

This is a big hurdle for new and small investors. After all, to make $1,000 per month in dividends, you’ll need about $400,000 with an average yield of 3%.

But, how do you reach $400,000?

Let’s start with a little bit of perspective. Dividend investing is long-term investing to the core. You’re not investing for growth—certainly not explosive growth—but for a steady income and, hopefully, a decent amount of appreciation along the way. That means you’ll need to think of it as a long-term investment, which requires both patience and consistent investing.

Start by deciding how much you plan to invest and do it on a regular basis. For example, you can choose to invest $500 per month, or even buy 10 shares per month of a particular stock.

As you go forward, you can gradually increase your investment contributions, eventually reaching the point where you’ll be adding many thousands of dollars each year.

That actually works out to be a good thing. Since you’ll be buying a little bit each month, you’ll be dollar-cost-averaging. That’s the best way to invest since it virtually ignores stock price or any end-of-market timing. You’ll just be investing the same amount each and every month.

The Magic of Compounding to the Rescue

For example, let’s say you invest $500 per month—$6,000 per year—in a growing portfolio of dividend stocks with an average return of 10%, including both dividends and capital appreciation.

Even if you never increase the amount you invest, you’ll have slightly over $400,000 in your dividend portfolio in 21 years. If you do increase your monthly contributions, you will reduce the number of years it will take. It all depends on how determined you are to build a true passive income portfolio, as well as the extra cash you have available to invest each month.

Now, an important part of this long-term growth strategy will be the reinvestment of dividends. During the time you’re building your dividend portfolio, you won’t be taking any income. Instead, you’ll use any dividends received to buy more shares of the companies you’re investing in.

This can easily be done through what is known as Dividend Reinvestment Plans, commonly known as DRIPs. They can often be set up through the broker where you hold the stock. By participating in a DRIP, dividends will automatically be used to buy more stock in the same company.

The combination of regular contributions, reinvestment of dividends, and capital appreciation will be the power behind the compounding that enables you to build a portfolio large enough to generate $1,000 per month in dividends.

The relationship between dividends and market value

Dividend-paying stocks provide a way for investors to get paid during rocky market periods, when capital gains are hard to achieve. They provide a nice hedge against inflation, especially when they grow over time. They are tax advantaged, unlike other forms of income, such as interest on fixed-income investments. Dividend-paying stocks, on average, tend to be less volatile than non-dividend-paying stocks. And a dividend stream, especially when reinvested to take advantage of the power of compounding, can help build tremendous wealth over time.

However, dividends do have a cost. A company cannot pay out dividends to shareholders without affecting its market value.

Think of your own finances. If you constantly paid out cash to family members, your net worth would decrease. It’s no different for a company. Money that a company pays out to shareholders is money that is no longer part of the asset base of the corporation. This money can no longer be used to reinvest and grow the company. That reduction in the company’s “wealth” has to be reflected in a downward adjustment in the stock price.

A stock price adjusts downward when a dividend is paid. The adjustment may not be easily observed amidst the daily price fluctuations of a typical stock, but the adjustment does happen. This adjustment is much more obvious when a company pays a “special dividend” (also known as a one-time dividend). When a company pays a special dividend to its shareholders, the stock price is immediately reduced. 

An Example of Dividend Investing

Suppose Anthony is 18 years old and he’s just gotten a job. He decides that he wants to start making money from stocks, so he begins to invest. He chooses shares of big blue chip firms. He looks for ones that show healthy growth, strong balance sheets, and a solid history of raising the dividends it pays out over time.

He wants to avoid taxes, so he opens a Roth IRA to hold these stocks. Anthony can add up to $6,000 to this account each year because he's younger than age 50 and that's the limit set by the IRS as of 2022.

This move gives him a great edge in tax planning because he'll never pay a penny in taxes on the gains he makes in this account as long as he follows Roth IRA rules. Contributions are made with after-tax dollars and they can't be deducted from income, so any money he takes out will be tax-free after five years.

Anthony is able to grow his money at 8% for the next 50 years. Thanks to compound interest, his portfolio grows to more than $3 million by the time he reaches 68 years old and decides to retire.

He could collect about $96,000 in dividends each year if he invested wisely and picked stocks with an average dividend yield of at least 3%. That's cash in his pocket. And he doesn't have to pay any taxes on this income because he holds the stocks within his Roth IRA account.

Sample of a Portfolio Generating $1,000 per Month in Dividends

To generate $1,000 per month in dividends, you’ll need to build a portfolio of stocks that will produce at least $12,000 in dividends on an annual basis. Using an average dividend yield of 3% per year, you’ll need a portfolio of $400,000 to generate that net income ($400,000 X 3% = $12,000).

I know you’re thinking that building a $400,000 portfolio is impossible, so why bother.

For the moment, just follow me in this section; we’ll get to building that $400,000 portfolio as the next topic.

The table below shows a portfolio—10 stocks, each with an equal investment of $40,000—that will generate more than $1,000 per month in dividend income. The stocks included are drawn from Dividend Aristocrats.

Company (Stock Symbol)Total InvestmentShare Price as of October 30, 2020Number of Shares OwnedDividend Yield PercentageAnnual Dividend Income
Archer Daniels Midland (ADM)$40,000$46.24865.052.92%$1,168
AFLAC (AFL)$40,000$33.951,178.202.70%$1,080
3M Company (MMM)$40,000$159.96250.063.60%$1,440
Cardinal Health (CAH)$40,000$45.79873.553.51%$1,404
Cincinnati Financial (CINF)$40,000$70.74565.452.80%$1,120
Consolidated Edison (ED)$40,000$78.49509.623.86%$1,544
Essex Property Trust (ESS)$40,000$204.59195.513.27%$1,308
General Dynamics (GD)$40,000$131.33304.582.99%$1,196
Genuine Parts Co. (GPC)$40,000$90.43442.333.21%$1,284
Coca-Cola (KO)$40,000$48.06832.293.12%$1,248
TOTALS$400,000N/AN/A3.20% (average)$12,792

Why I Didn’t Include Stocks with the Highest Dividend Yield

Now, I didn’t necessarily include those companies with the highest dividend yield.

When we were discussing which dividend stocks to invest in, I listed several criteria for choosing stocks most likely to continue paying high dividends for the foreseeable future. For that reason, I’ve excluded certain stocks that might not make the cut.

For example, AbbVie has a dividend yield of 4.96%—that would look good in any portfolio, right? But, they have a dividend payout ratio of 100%, which means they’re not reinvesting in building the company. That can compromise future dividend payments.

An even more extreme example is Exxon Mobil, currently paying 9.42%. With a dividend payout ratio well over 400%, they’re a prime candidate for a dividend cut or even a dividend elimination.

How are dividends determined, and how often are they paid?

It’s up to a company’s board of directors to decide how much, when and how often dividends are paid. Boards develop dividend payout policies based on factors like projected growth, income stability, reinvestment opportunities and competitors’ policies.

Companies often choose to issue dividends on a monthly, quarterly or annual basis. After a dividend payout is approved by the board, companies announce the dividend, its amount, the ex-dividend date and the payment date to shareholders on the declaration date. Shareholders must approve this before payments can be made.

How are dividends taxed?

Dividends in the UK are taxed at different rates depending on the tax band you are in.

For the 2022/23 tax year, dividends are taxed as follows:

  • Basic rate taxpayers: 8.75%
  • Higher rate taxpayers: 33.75%
  • Additional rate taxpayers: 39.35%

Tax rates can change, so always check the relevant government advice for further information on the subject.

💡 Learn more about taxes with our investment tax guide.

Dividend allowance

The UK dividend allowance lets investors earn a certain amount of dividend income each tax year and not pay tax on it.For the 2022/23 tax year the dividend allowance is £2,000.Again, be aware that this figure can change in the future so make sure you keep up to date with the latest guidance provided by the UK tax authorities.If you open an ISA account and use it to invest in dividend-paying UK stocks you can also shield yourself from some taxes. The same is true of a SIPP pension account.

But remember that most non-UK stocks, including the US, will have dividend income taxed at source. So even if you buy them in a tax-efficient account, like an ISA or SIPP, you’ll still be paying that tax.

What Is Dividend Yield?

Dividend yield is a way of understanding the relative value of a company’s dividend payment. Yield is expressed as a percentage, and it lets you know what return on investment you’re making when you earn a dividend from a given company.

Since dividends are paid as a set amount per share, it can be difficult to compare dividend payments across companies given their different share prices. Dividend yield provides an handy way to measure and compare which stocks pay the most dividends per dollar you invest.

How to Calculate Dividend Yield

To calculate dividend yield, divide the stock’s annual dividend amount by its current share price.

Let’s say the stock ABC is trading at $20 per share, and the company pays a quarterly dividend of 10 cents per share. For the year, ABC’s dividend would be 40 cents. Divide 40 cents by $20 per share to arrive at a dividend yield of 2%.

Dividend yield lets you compare the value of dividends from different companies. Stock XYZ, for example, might pay a higher quarterly dividend than ABC of 20 cents per share, for a total annual dividend of 80 cents. Since shares of XYZ are valued at $75 per share, though, the dividend yield is only 1%.

The dividend yield you’d earn from owning shares of ABC is better than XYZ’s—at least until the shares’ values or dividends change.

Dividends FAQs

Do you get dividends for owning fractional shares?

Yes, you will usually receive dividends in proportion to the fraction you own. So if you owned half a share, you’d get half of the dividend per share paid out.

How do stock split and stock dividends differ?

Stock splits and stock dividends are very similar. The difference lies in the goal behind it. A stock split is usually designed to reduce a company’s share price so they’re more affordable to investors. In contrast, a stock split is supposed to provide more equity in the company.The thing is, in both cases new stock is issued and given to existing shareholders. The effect is such that the share price falls in proportion to the number of new shares issued. For example, a 2 for 1 stock split would double the number of shares in issue but halve their value. It’s for this reason that some investors are opposed to stock dividends, as unless the share price rises, they don't actually gain anything from it.

Where to find dividends on a financial statement

Dividends are listed on a company’s cash flow statement as a use of cash.

If a public company never pays dividends is the company worthless?

No, a company’s decision not to pay dividends tells you very little. It could be a terrible company or an amazing company. Many major US tech companies, for example, do not pay dividends. It depends on their goals and if they have big plans to put their profits to work in generating more growth, or if the firm has hit such maturity that shareholders expect a dividend policy to be in place.

How can I easily tell if a company pays dividends

Nearly all listed companies have an investor relations website or service. Checking this is a simple way to see if they don’t pay dividends. Other alternatives are to check with respectable financial data providers.

How do you track your dividends

Dividends are usually paid as cash into your brokerage account. You will likely be notified when and how much you have been paid. But as dividends are cash, the money you receive will look like any other money in your account and there won’t be a separate section or part of your account devoted solely to dividend payments.

How do dividends affect stock prices?

Dividends typically have a negative effect on a company’s share price. Remember that from the ex-dividend date onwards, a share ceases to have the rights to the upcoming dividend tied to it.That means a company’s shares should, in theory, fall in price by the value of the dividend on that date. So if a company had shares worth £1 and was going to pay a £0.10 dividend then you’d expect the shares to drop in value to £0.90 on the ex-dividend date.In the US, exchanges actually mark down the price of a share by the value of the dividend prior to the resumption of trading on the ex-dividend date. Other countries do not have the same system but market participants typically sell off to reflect the fact that the company should drop in value in proportion to the amount of money it paid out in dividends.

Dividends on Freetrade

Lots of companies on Freetrade pay dividends and if you invest in any that do then you’ll receive that cash into your account. Alternatively you’ll receive new shares if a company performs a stock dividend.

We’ve also written a lot about dividend investment strategies and the companies that pay them, so have a read of the following if you’d like to learn more.

Make your investments work a little bit harder with one of the UK’s leading commission-free trading apps. Freetrade has transparent charges, no hidden fees and is one of the only brokers to offer fractional shares in the UK

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