Every investor understands the value of dividends. It’s one of the shrewdest ways to make “extra” money. In fact, 75% of returns from the S&P 500 from 1980 to 2019 came from dividends. Investors are especially excited by the significant tax advantages, reduced portfolio risk, and high investing profits.
However, all those benefits don’t come risk-free. You must be prepared to toil and wait patiently as with any other investment. Most importantly, you must understand the dividend investment landscape well to make the right moves.
Focusing specifically on monthly dividend stocks, we’ve identified seven critical need-to-know points that can be very important as you make your first moves with monthly dividend stocks.
Monthly dividend stocks are securities that pay dividends every month rather than quarterly or annually. Armour Residential Inc., Dynex Capital Inc., Realty Income (O), and EPR Properties are excellent examples.
The two main advantages of monthly dividend stocks are reinvestment and compounding. Reinvestment means using dividends or other income streams from an investment vehicle to purchase additional shares or stock units rather than receiving the payout in cash. Meanwhile, compounding means reinvesting your proceeds to generate additional earnings over time. Monthly dividends generate very high reinvestment and compounding returns.
Unfortunately, monthly dividends aren’t very common. Of more than 3,000 publicly traded companies that pay dividends regularly, only about 50 pay monthly dividends. The main reason is that most companies don’t generate enough profits to pay dividends every month.
Many companies that pay monthly dividends are real estate investment trusts (REITs) and closed-end funds. REITs can pay monthly dividends because they receive monthly rents. Meanwhile, closed-end funds are required by tax law to payout the majority of their income to shareholders, thus need to redistribute their earnings regularly to avoid taxation. So, they, too, find a significant incentive in paying monthly dividends.
When a company declares a dividend, it will simultaneously announce the ex-dividend date. The ex-dividend date is the date after which you cannot use the current dividends to purchase new shares. So, if you wish to reinvest your dividends by purchasing additional shares in the paying stock, you must do so before the ex-dividend date. Otherwise, you’re locked out.
Many investors view regular dividends, such as monthly dividends, as a sign of positive growth and the ultimate indicator of the paying company’s financial health. However, this isn’t always true. Instead, it’s sometimes a sign that the company isn’t generating enough earnings to invest in meaningful projects. This isn’t a good sign.
All dividends are taxed. In fact, it’s one of the best examples of double taxation. The company first pays tax on the income from which it pays dividends. Then the dividends are also taxed as soon as they hit the investor’s brokerage account. Dividend tax rates vary from 5% to 15%.
Many monthly dividend stocks are highly speculative, with a small margin of error. This means that it takes only a small hitch for most companies to stop paying monthly dividends. Furthermore, a high payout ratio often means the company is investing less and less in future growth. This can quickly water down a stock’s value.
The bottom line is that monthly dividend stocks can be incredibly valuable when used correctly. However, they require just as much interrogation as other valuable investments to avoid common pitfalls.