Several years ago I knew that dividends were a good source of passive income and that passive income was a great entity to pursue. However, I didn't know how to pick good dividend stocks or have any plan/reinvestment strategy for my dividends once I received them.
Picking the right dividend stocks I will cover in a different post but one of the most important factors for dividend investing success is the system that you place around your dividends to grow and compound your returns.
This still sounds abit too complicated for my liking so let's start with a dividend investing goal.
"To make your dividend portfolio SELF FUNDING"
So what do we mean by this : Basically we want to use our earned money e.g. salary to purchase our dividend paying stocks and then use the dividends received to buy more stocks. The beauty of this scenario is that we start off buying all of our stocks and then the stocks start buying themselves !
There are two approaches you can take with this strategy one is 'capped' and the other is 'uncapped'.
CAPPED EXAMPLE
In this example the cap refers to the maximum amount we will invest in our dividend portfolio each month. To keep the numbers simple I have selected £100, your amount will depend on your circumstances and attitude towards risk. Lets imagine your timing is good and you catch a
record date for a stock that has a
payment date the month after.
August
Dividend received : zero as you have not previously purchased any stock.
Salary : £100 from your salary goes into buying your first dividend stock.
Amount invested :£100
September
Dividend received : £5 received from the dividend stock you purchased the previous month which can now be reinvested.
Salary : £95 from your salary goes into buying more dividend stocks
Amount invested :£100
October
Dividend received : £7 received from the dividend stock you purchased the previous month which can now be reinvested.
Salary : £93 from your salary goes into buying more dividend stock.
Amount invested :£100
In summary you cap your investment amount at a figure in this case £100 and then use your dividends received to reduce the amount you have to put in from your salary each month. This is great because you still invest £100 and you also get to save your own salary for use elsewhere in your life !.
UNCAPPED EXAMPLE
So this approach is much simpler you still decide on an amount each month that you want to invest but you never reduce that amount even when you receive dividends. To use the examples above the monthly invested amounts would be.
August : £100
September : £105
October : £107
As you can see you will increase your portfolio worth faster but it all comes down to your personal choice.
I stated earlier that the goal is for the portfolio to become self funding and this is what I am working towards. For the above portfolio to become self funding you would need to be receiving £100 a month in dividends. If you are using the capped method you can at this point cease your salary payments into your portfolio and just reinvest the dividends received. Thus the portfolio is funding itself.
This has been a very successful strategy for me and if you are going to try this approach, are already doing something similar or have your own strategy it would be great to hear from you in the comments section.
