It’s a question I get from investors all the time: “Should I take my dividends in cash or reinvest them through a dividend reinvestment plan (DRIP)?”
My answer: unless you want your cash sitting in your account earning zero, your best bet is to reinvest any dividend money you don’t need to pay your bills.
But we don’t want to practice “buy and hope” investing, either, whether we do it through obsolete DRIPs or the old-fashioned way.
When I say “buy and hope,” I mean putting your cash into household names like the so-called Dividend Aristocrats and “hoping” for higher stock prices when you cash out in retirement.
You’ve probably heard of the 53 stocks on the Aristocrats list, which have raised their payouts for at least 25 straight years.
Trouble is, despite their lofty name, these companies hand us a pathetic current dividend of 2.2%, on average.
And many pay a lot less!
So if you invest mainly in these stocks (as many people do), you won’t have to worry about reinvesting your dividends. You’ll need every penny of dividend income just to keep the lights on!
That’s because even with a $1-million portfolio, you’re only getting $22,000 in dividend income a year here, on average. That’s not far above poverty-level income for a two-person household.
Pretty sad after a lifetime of saving and investing.
Luckily, there’s a way we can rake in way more dividend cash. I’m talking a steady $75,000 a year in income on a million bucks.
And if you’re not a millionaire, don’t worry: a $550k nest egg will bring in $41,200 annually, enough for many folks to retire on.
That’s 59% more income than our million-dollar Aristocrat portfolio, from a nest egg that’s a little over half the size!
How to Bank an Extra $41,200 in Cash Every Year
I know what you’re thinking: “Brett, that amounts to a 7.5% yield. There’s no way a payout like that can be safe.”
You can be forgiven for thinking that, because you hear it everywhere.
But the truth is, there are plenty of safe payers throwing off at least that much, like the 19 stocks and funds I recommend in my Contrarian Income Report service.
Right now, these 19 sturdy investments yield 7.5%, on average.
And every month I personally run each one through a rigorous dividend-safety check, starting with 3 things that are absolutely critical:
- Rising free cash flow (FCF)—unlike net income, which is an accounting measure that can be manipulated, FCF is a snapshot of how much cash a company is making once it’s paid the cost of maintaining and growing its business;
- A payout ratio of 50% or less. The payout ratio is the percentage of FCF that went out the door as dividends in the last 12 months. REITs use a different measure called funds from operations (FFO) and can handle higher payout ratios, sometimes up to 90%;
- A healthy balance sheet, with ample cash on hand and reasonable debt.
Making DRIPs Obsolete
The best part is, these 19 investments are perfect for dividend reinvestment because each one gives us a dead-giveaway signal of when it’s time to buy, sit tight—or sell and look elsewhere for upside to go with our 7.5%+ income stream.
That makes DRIPs obsolete!
Because why would we mindlessly roll our dividend cash into a particular stock every quarter when, at a glance, we can pinpoint exactly where to strike for the biggest upside?
To show you what I mean, consider CEFs, an overlooked corner of the market where dividends of 7.5% and up are common. We hold 11 CEFs in our Contrarian Income Reportportfolio, mainly larger issues with market caps of $1 billion or higher.
We don’t have to get into the weeds, but CEFs give off a crystal-clear signal that a big price rise is coming.
You’ll find it in the discount to NAV, which is the percentage by which the fund’s market price trails the market value of all the assets in its portfolio.
This number is easy to spot and available on pretty well any fund screener.
This makes our plan simple: wait for the discount to sink below its normal level and make your move. Then keep rolling your dividend cash into that fund until its discount reverts to “normal.”
That’s exactly what we did with the Nuveen NASDAQ 100 Dynamic Overwrite Fund back in January 2017—and the results were breathtaking.
How We Bagged a 42% Total Return (With a 7.5% Yield) in 15 Months
QQQX is run by portfolio manager Keith Hembre, who cherry picks the best stocks on the NASDAQ, juices their high yields with a safe options strategy, then dishes distributions out to shareholders.
It’s hard to imagine now, after the huge run tech stocks have put in over the past couple years, but back in January 2017, QQQX was trading at a 6% discount to NAV and paid a 7.5% dividend.
That triggered our initial move into the fund.
And over the next 15 months, we bagged two dividend increases and watched as QQQX’s discount swung to a massive premium—so much so that by the end of that period, the herd was ready to ante up $1.13 for every buck of assets in QQQX’s portfolio!
That huge swing from a discount to a premium catapulted us to a fat 42% gain.
But the fund’s outrageous premium meant its upside was pretty well maxed out by the time we took our money off the table on April 6, 2018.
And what’s happened since?
QQQX has moved up slightly—a 1% gain. But that’s way behind the market, which has cruised to a 7.5% rise.