How to Make Passive Income from Dividends
Passive income is the dream of most investors, since it enables them to get a continuous stream of income without having to put too much time into earning it after the initial setup. Unlike active income sources like owning a store, passive income allows you to grow your income base over time without eventually getting overwhelmed and being unable to grow further.
When most people think of passive income, they tend to think of owning a business that is managed by others. A famous example Shaquille O’Neal, who now owns 155 Five Guys, 150 car washes, 40 fitness centers, 17 Auntie Anne’s Pretzels, and a shopping center. By the time we are finished writing this article, we assume he’ll own even more. Shaq is a perfect example of classic passive income. But there is another type of passive income that requires very low setup costs, and which anyone can start.
We are talking about passive income from stock dividends – one of the best options for passive income available to the average investor.
What are dividends?
Dividends are money that a public company gives directly to shareholders. Dividends are used as a way for companies to give profits back to their owners – the shareholders. So, all you have to do to get a dividend is to buy a dividend-paying stock. Dividends are paid on a per-share basis, so the more stocks you own the more dividends you receive.
Dividends are paid only when the company leadership decides to pay them and are usually paid either annually or quarterly. Sometimes a company will pay a ‘special dividend’ when it has an unusually high one-time profit or is sitting on a large amount of cash. For example, in 2000 the Ford Motor Company paid its shareholders a special dividend of $10 billion – the largest special dividend in American history at the time – to give some of its $24 billion cash reserves back to shareholders.
Dividends are paid out of company profits, so larger and more profitable companies are more likely to pay dividends. However, it is important to note that dividends can be stopped at any time, so buying a stock that pays a dividend today does not mean it will always do so.
When researching dividend stocks to buy, it is important to remember the key rule of investing: you focus on your return. Buying a stock is not free, and often is not cheap, so the dividend you receive from the stock should compensate you well for the purchase cost.
To find out your rate of return, you should look at a stock’s Dividend Yield. The dividend yield of a stock is calculated by dividing the annual dividends paid by the stock by the its purchase price. So, for example, a stock that costs $100 and pays $10 in dividends each year would have a dividend yield of $10/$100 = 10%.
It is important to note that dividend yield is higher not just for stocks that pay high dividends, but also for stocks that are less expensive to buy. So, you can get a high return from dividends either by looking for high dividend payments or by finding less expensive stocks that pay reasonable dividends.
Luckily, dividend yield is a very common financial measure, and can be found on pretty much any online financial database such as Yahoo Finance.
How can you find and buy dividend stocks?
Finding dividend paying stocks is very easy using online financial search tools like Yahoo Finance. You can then buy these stocks through any platform that enables stock purchases, including Charles Schwab, Fidelity, E*Trade, and Robinhood. However, please remember that buying stock is usually not free – each time you buy and sell a stock on these platforms you usually have to pay a commission fee. A notable exception to this Robinhood, which offers commission-free trades.
Another option for finding and buying dividend paying stocks is to buy a dividend-focused Exchange Traded Fund (ETF). ETFs are baskets of stocks that are also traded on stock exchanges. There are many different types of ETFs, including those which only buy dividend paying stocks. You can usually search and buy ETFs through the same companies listed above. ETFs have a major advantage in that they cover a wide range of dividend paying stocks, lowering the risk of buying just one stock that may drop in value or stop paying dividends in the future.
Reinvesting dividend income
For anyone looking to grow their dividend income, a common strategy is called ‘dividend reinvesting’. This means that all dividends received are used to purchase more of the same stock, enabling even more dividends to be received in the future. This is a method for increasing an investor’s passive income base, and so increase their total future income. This strategy is so common that almost all major financial platforms have options to automatically reinvest dividends.
And this strategy is profitable – with one study estimating that 43% of the average annual return of the S&P 500 Index (which includes the 500 largest public companies in the America) since 1930 coming from dividends.
Start Making Passive Income With Dividend Stocks
If you think dividend investing is for you, then we first recommend doing a good deal of research. All investing carries the risk of losing money, so you need to be prepared before purchasing anything. This article from Acorns is a good place to start.
After researching enough to be comfortable with dividend investing, you can then contact any major financial broker to open an account and start trading.
- Jaynes, Dwight. “Why Is Shaq Still Hawking Stuff?” NBC Sports, NBC Sports, 17 Nov. 2017, www.nbcsports.com/northwest/nba/shaq-worth-400-million-so-why-he-still-hanging-out-cartoon-general.
- “Ex-Dividend Dates: When Are You Entitled to Stock And Cash Dividends.” Investor.gov, Securities and Exchange Commission, https://www.investor.gov/additional-resources/general-resources/glossary/ex-dividend-dates-when-are-you-entitled-stock-cash.
- Bradsher, Keith. “Ford Motor to Pay $10 Billion Dividend and Ensure Family Control.” Nytimes.com, The New York Times, 15 Apr. 2000, https://www.nytimes.com/2000/04/15/business/ford-motor-to-pay-10-billion-dividend-and-ensure-family-control.html.
- “What Is An ETF?” Fidelity, Fidelity, 2019, www.fidelity.com/learning-center/investment-products/etf/what-are-etfs.
- “Have You Heard About the Power of Reinvesting Dividends?” Power of Reinvesting Dividends | Edward Jones, Edward Jones, www.edwardjones.com/market-news-guidance/personal-finance/reinvesting-dividends.html.