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Using Dividends to Improve Returns

On May 21, I posted some important information about stock dividends (which includes dividends paid by ETFs). But there is an important point to be made for investing in dividend paying stocks. It's the same as compound interest on savings.

Phil Town calls it Payback Time. The basic premise is to re-invest dividend payments from stocks to reduce the overall cost of ownership. If you hold the stock long enough (not always possible), eventually your cost is zero.

Let's look at a real example using AT&T (T). The information here is based on actual data from Yahoo's finance website.

We purchase 500 shares on June 5, 2014 for $35.02 a share. This is an investment of $17,510, which is also called our basis. We also make sure to instruct our broker to reinvest all dividends by buying extra shares, which will be purchased at the market rate, usually the day after the dividend is paid.

We are actually going to buy extra shares without using our own money. We will use the dividends paid by the company.

The average price of AT&T over the last five years has been about $35 a share, so at today's prices, the stock is a little less expensive. We might consider that it is selling at a discount. Morningstar gives it a fair value of $37 a share, so our current holding looks safe. We'll continue to collect dividends and add shares to our position. In another five years, our dividend income should be up to at least $1,800 a year. 

You can't retire on this investment alone, but it's a start. If you build a portfolio of 5 or 6 dividend paying stocks (look for companies that have a record of raising dividends each year), it will keep growing faster as time goes on. Keep adding to your positions on a regular basis, especially when prices are low. 

As of June 6, 2019, the value of our AT&T stock is $21,049.99. We currently own 655.76 shares, because we purchased an extra 155.76 shares by reinvesting the dividends. So even though the price per share of the stock is down about $4 per share, the value of our stock has increased $3,539.99, a 20 percent increase. This will not make you rich, but over time, especially if you've put the stock in a tax-free account, such as a Roth IRA, the gains you make are tax free and will grow faster as time goes on.

The chart below details the numbers. This should be considered a long-term investment. Take a look at the company a couple of times a year to make sure it's still something you want to own. 

Ex-Date Div/Share Close Price Dividend #Shares Total Shares Market Value
7/8/2014 0.46 35.56 230.00 6.47 506.47 18,010.00
10/8/2014 0.46 35.15 232.98 6.63 513.10 18,035.32
1/7/2015 0.47 33.17 241.16 7.27 520.37 17,260.55
4/8/2015 0.47 32.65 244.57 7.49 527.86 17,234.53
7/8/2015 0.47 34.74 248.09 7.14 535.00 18,585.84
10/7/2015 0.47 33.12 251.45 7.59 542.59 17,970.60
1/6/2016 0.48 34.06 260.44 7.65 550.24 18,741.07
4/6/2016 0.48 38.64 264.11 6.84 557.07 21,525.27
7/8/2016 0.48 43.10 267.39 6.20 563.28 24,277.21
10/5/2016 0.48 39.16 270.37 6.90 570.18 22,328.27
1/6/2017 0.49 41.32 279.39 6.76 576.94 23,839.25
4/6/2017 0.49 40.60 282.70 6.96 583.91 23,706.56
7/6/2017 0.49 37.18 286.11 7.70 591.60 21,995.71
10/6/2017 0.49 38.59 289.88 7.51 599.11 23,119.76
1/9/2018 0.50 37.49 299.56 7.99 607.10 22,760.29
4/9/2018 0.50 35.17 303.55 8.63 615.73 21,655.36
7/9/2018 0.50 32.15 307.87 9.58 625.31 20,103.71
10/9/2018 0.50 33.50 312.65 9.33 634.64 21,260.53
1/9/2019 0.51 30.10 323.67 10.75 645.40 19,426.42
4/9/2019 0.51 31.75 329.15 10.37 655.76 20,820.47
35.86 5525.11 155.76

The bottom line shows the average close price, the amount of dividends collected and the number of share purchased.

One warning. Even with these types of investments, I would not ride out a bear market, unless I had 20 years ahead of me before retirement. Learn and watch the indicators, and get into cash or money markets. When you get back in a lower prices later, you'll be glad you sold. You'll be buying even more shares. This is called stockpiling, no pun intended. 

Also, the way your broker keeps track of these investments is different from the way I'm doing it. Your broker will use each purchase with its own basis for reporting, and the costs will look different than presented here. This is necessary for income tax purposes, should you sell your holdings. Of course, if you build your investments  inside of a Roth IRA, when it comes time to withdraw your earnings, they'll be tax free.

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