How Often Do You Want to Get Paid?
If you’re already retired, you need your portfolio to generate current income.
And if you’re living off of your portfolio, then you want to get paid regularly—preferably each and every month.
The traditional way to do this is to select a dozen reliable dividend stocks whose payouts are spread across each of the three quarterly dividend payment cycles.
Payment cycles are based on the first month of the year in which a company’s dividend is payable to shareholders.
For instance, a company whose first dividend of the year is payable in January will generally be on a January/April/July/October payment cycle.
When setting up your portfolio, ideally you’ll want to have those payouts staggered—four stocks that pay in January, four that pay in February, and four that pay in March.
With dividends paid out each quarter thereafter, this approach ensures you’ll enjoy regular income from four dividend stocks each and every month.
Spread Your Bets
Of course, payment cycles aren’t your only consideration. When your paycheck comes from dividends, you need your income to be reliable.
To this end, you’ll want to diversify your holdings across industries.
After all, individual sectors can suffer downturns even when the overall economy is doing fine.
Diversification helps ensure your portfolio won’t be overexposed to any one sector.
But diversification is only one way to reduce risk. You also need to consider what’s happening at a company level.
Check Their Credit
Here, it’s a good idea to focus on a company’s credit.
Basically, you want a company that can comfortably manage all of its obligations, from interest payments on debt to dividend payments to shareholders.
Naturally, some companies are able to shoulder more debt than others. Regulated utilities, for instance, are generally given the most leeway, while highly competitive sectors are expected to keep a lid on leverage.
If you have access to a stock screener, you can get a sense of what is permissible for each sector by viewing the averages for credit metrics such as debt to equity and debt to EBITDA (earnings before interest, taxation, depreciation, and amortization).
When it comes to leverage, in most cases lower is better. At the very least, you’ll want to favor companies whose metrics come in below their industry average.
If that sounds overly technical, then you can simply defer to credit-rating agencies such as Moody’s and Standard & Poor’s. Look for companies that have investment-grade credit ratings, where the agency’s outlook is listed as “stable.”
Through Thick and Thin
Similarly, on the dividend front, you want a company that can sustain its payout over time, even if its business temporarily hits the skids.
The payout ratio is what income investors typically check first—lower is generally better. But the payout ratio won’t always tell you the full story.
That’s because earnings calculated according to generally accepted accounting principles may not reflect a company’s true ability to fund its payout from the cash it generates.
Sometimes profits can come in lower due to one-time items. Other times, earnings are lower due to non-cash items that don’t affect cash flows.
Additionally, some dividend-paying sectors are comprised of companies that distribute most of their cash to shareholders, such as real estate investment trusts (REITs) and master limited partnerships (MLPs). That can make their payout ratios look downright alarming.
Consequently, these sectors use different profit metrics than earnings per share—funds from operations (FFO) for REITs and distributable cash flow for MLPs.
To gauge the sustainability of a REIT’s distribution, look for its FFO payout ratio—lower is better. For an MLP, look for its distribution coverage ratio—1.1 times or higher is better.
A High-and-Rising Paycheck
Lastly, you want your income to grow over time.
Some dividend payers have a great deal of visibility into future earnings and dividend growth, especially if they have regulated or highly contracted businesses.
Accordingly, their management teams can give investors a good idea of what to expect over the next three to five years.
For companies in more competitive sectors, check their record of dividend growth over the past three to five years. That should tell you whether management shares the wealth with investors.
So those are the basics of how you build a portfolio that will give you a steady stream of income each and every month.
Take the Controls
But there is another way.
There are two main shortcomings to the traditional approach of generating monthly income from dividend stocks.
For one, the company controls when you get paid.
And even when you’ve done all your homework, it’s impossible to anticipate every risk a company might face.
Bad things can happen to good companies (and diligent investors).
If a company is facing a serious problem, it will suffer a decline in share price and may even be forced to cut or suspend its dividend.
To overcome these challenges, my colleague Jim Fink has pioneered an income-investing strategy that helps his subscribers control when they get paid, how often they get paid, and how much they get paid.
Equally important, his approach significantly reduces the risk of investing in any one sector or company.
Jim’s income-generating techniques put investors firmly in control of their paycheck. In fact, he’s about to tell his subscribers how to generate another instant payment on April 19.