## Wednesday, June 20, 2012

### Make A Plan And Stick To It

Dividend investing is fundamentally simple.  If you can grasp four-function math and plug data into an Excel spreadsheet you should have no problem determining the financial health of a company (I'm assuming you can understand key parts of annual reports, such as the cash flow statement) as well as the amount of income owning shares it in will provide.  It is because of this that writing things like "How to earn \$1,000 a month in dividends" is mostly a waste of reader's time.  Here is all you need to know:
 Earn \$1,000/month Yield Portfolio Size 2.50% \$480,000 3.00% \$400,000 3.50% \$342,857 4.00% \$300,000 4.50% \$266,667 5.00% \$240,000

The equation for the above chart is ((Monthly Income Goal)*12)/Yield = Portfolio Size.  Go forth and be wealthy (and calculate your own tax bill).

Seriously, if you have a few hundred grand lying around and want to generate some income with it all you need to do is put together a basket of dividend paying stocks with an average yield that will generate the amount of income that you desire.  Hell if you wanted to you could drop it just on REITs that are paying more than 10% and really make some cash.  Of course as you chase after higher yields you are going to have to accept higher risk to both your principle and your income stream.  Its somewhat difficult to pay out 10% of your earnings in dividends and then increase that payout by 10% every year for the next few decades.  Possible, but difficult.

For the rest of us who are still building our portfolios the focus has to be split between income now and income in the future.  The income generated now should be plowed right back into the portfolio so that it can generate more income which can be re-invested and so on and so forth.  Additionally the companies that it is re-invested in should have both a history of dividend increases and also the financial stability to ensure future dividend increases as well.  The income in the future is the goal that is being worked towards, whether it be \$1,000/month, \$5,000 a month, or some other figure.  To get there you simply need to determine how much more money you need to invest to get from where you are now to your goal income.

Okay, so maybe its not that simple.  You also need to make sure your future projections take into account inflation (\$50,000 now will have less purchasing power in the future) and judge how much dividend growth rates are going to assist you.  Your basic calculations might have told you that you need to contribute another \$500,000 to reach your income goal but by taking into account dividend growth rates that number would be lowered significantly.  Inflation works the other way as it subtracts from your real return. When searching out new investments it would behoove you to ensure that the dividend growth rate (or projected capital appreciate rate according to a conservative estimate) is greater than inflation.  If it isn't you need to re-evaluate your strategy.

So here is the plan: open up Excel and set up a basic spreadsheet.  Your inputs are going to be the current size of your portfolio, its current yield (based on current dividends and the price you purchased stocks at, NOT the current yield of the stocks), the average dividend growth rate that you project going forward, an inflation constant (between 2.5% and 3% should be fine) and the amount of additional contributions you will add to the portfolio each year.  What you are trying to determine is what combination of those inputs is required for you to reach your target income level as soon as is reasonably possible.

The above process should take you less than ten minutes.  Once you have the numbers figured out its time to actually build the portfolio that is going to aim to meet or exceed your target goal.  This is where individual stock analysis comes into play and for that you can refer to the related posts listed at the bottom of this article (why write something twice when I can just link to it?).

Like I said in the beginning the concept of dividend investing is easy, its the execution of the concept that takes practice to master.  Always understand how each investment that you buy into fits into your pursuit of your financial goals: if it doesn't fit then don't blow your money on it.  Stick to that which is simple and is proven to work and you will be able to live off of your dividends.

This post was included in The Wealth Builder Carnival #83 at My Wealth Builder.

Related Post: How To Build A Dividend Growth Stock Portfolio
Related Post: How To Read A Cash Flow Statement
Related Post: Dividend Yield vs Dividend Growth
Related Post: Understanding Return On Equity

Looking for more financial advice but getting tired of me going on and on about dividend stocks all the time? Head on over to 6400personalfinance.com and follow me on Twitter @6400PF for a broader approach to building your net worth.