Monthly Dividend Stocks
By: Ned Piplovic,
While quarterly dividend-paying equities with steadily rising distribution payouts should be a cornerstone of every investment portfolio, investors who seek more frequent income disbursements should consider taking advantage of monthly dividend stocks, especially good quality equities that offer decent capital gains, to complement their monthly income distributions.
Based on historically back tested data, equities that maintain rising dividend distributions tend to outperform equities with either no dividend distributions or declining dividend payouts. Therefore, if equities with steady quarterly dividend distributions offer strong returns, monthly dividend stocks should be even more advantageous and desirable. On the surface, monthly dividend stocks offer two main advantages. The first advantage is obviously the more frequent income distributions that investors receive.
While many investors have other sources of income and focus on long-term goals for their investment portfolio, such as investing for retirement, some investors use the dividend income distributions from their portfolio to cover their ongoing expenses. As many expenses occur on a monthly basis, these investors favor the distribution schedule of monthly dividend stocks.
Obviously, seasoned investors could attempt to generate a portfolio that generates a monthly dividend income by selecting equities with quarterly dividend distributions that have staggered dividend pay dates. However, that strategy is difficult to execute successfully and might limit the options for some months. A less-than-optimal portfolio strategy most likely would reduce total returns. While most companies decide their dividend payouts in line with their quarterly results, the availability of quarterly dividends with the January, April, July and October payout schedule will be significantly bigger than stocks with a February, May, August and November payout schedule.
Furthermore, with different stocks providing the income for different months, the monthly income level would most likely fluctuate and might not meet the monthly expenses. Even with this approach, the monthly income payments still would vary. Obviously, the monthly dividend income can be regulated by buying different amounts of shares based on the dividend per share payout to smooth out the distributions. However, finding few high-yield monthly dividend stocks is much simpler and significantly easier to manage. Furthermore, instead of trying to build a portfolio that delivers monthly dividend distributions, investors can consider using monthly dividend exchange-traded funds (ETFs) to accomplish the same goal of generating monthly income flows for the sole purpose of covering current expenses.
While some investors will use monthly dividend payouts to cover their ongoing expenses, others will reinvest these dividend payouts and take advantage of the second main benefit of monthly dividend stocks — more frequent compounding.
Instead of waiting full three months to receive a quarterly dividend distribution, monthly dividends allow investors to receive a portion of that income every month and reinvest the money right away. Even if the total annual dividend amounts are identical, the compounding effects will deliver significantly higher total returns for monthly distributions.
While the compounding effects offers an advantage from the beginning, the real effects are more significant over very long time horizons. Assuming a 6% annual rate of return, monthly compounding delivrs a 6.23% advantage for the first year over quarterly compounding. By the end of the second year, the advantage increases to 13.2%.
In just six years monthly compounding of the same annual dividend payouts deliver returns that are 50% higher than returns generated by distributing the identical dividend amount quarterly. By the end of the first decade, the returns from monthly compounding are twice the returns with quarterly distribution schedule. As with all compounding, the difference grows exponentially as the time horizon extends. While only double after the first decade, the returns from compounding monthly dividend payouts is five-fold higher than the returns from quarterly payouts at the end of the second decade.
Currently, a few thousand equities offer monthly dividend distributions. However, with such a large number of available options, the diversity is not as high as it might appear at first. Many of the monthly dividend stocks are not even stocks, but rather closed-end funds that invest in stocks, bonds and other equities.
Closed-end funds trade units, or shares, on various stock exchanges, but with some limitations. Unlike stocks of regular companies or ETF stocks that trade continuously throughout the trading session, mutual funds can be traded only after the trading closes. After closing, mutual funds reconcile the price changes of all underlying holdings to determine the new aggregate unit price for the fund.
Additionally, the fund’s managers actively control the underlying holdings and the makeup of the fund, which can change daily. However, mutual fund managers only need to file the fund’s holdings on a quarterly basis. Therefore, investors can find it difficult to have up-to-date holdings lists and the relevant share of total assets to make optimal investing decisions.
While mutual funds that offer monthly distribution are certainly viable options, investors can create their own individual monthly income portfolio or select a monthly dividend ETF. Unlike mutual funds, ETF stocks can be traded continuously throughout the trading session and their holdings are published daily. This offers investors all the information that is necessary to make educated decisions about where to invest.
Additionally, mutual funds generally carry higher management fees than ETFs and certainly sport higher transaction fees for trading stocks. Therefore, in addition to a few of the already-mentioned disadvantages, mutual fund fees also diminish long-term wealth accumulation. While the fee difference might be only a few percentage points, the wealth difference can be significant over a very extended time horizon when compounded over a couple of decades.
Another equity type that frequently offers monthly dividend distributions are real estate investment trusts (REITs). Monthly rent collections lend themselves to similar timing on the dividend distribution side. Furthermore, REITs generally funnel most of their earnings through to their investors as dividend distributions, which leads to very high dividend yields for investors. The reason for this course of action is that according to IRS rules, REITs must distribute at least 90% of their earnings as dividends to avoid paying corporate income taxes. Monthly dividend distributions allow REITs easier management of the complicated tax system that is associated with the real estate business.
While the monthly income payouts are the same from the perspective of investors, revenue generation differs slightly between equity and mortgage REITs. Equity REITs own real properties, such as factories, warehouses, office buildings, health care facilities, malls, apartments, etc. The monthly rents that are collected from tenants generate the revenue. Alternatively, mortgage REITs own various real estate financing vehicles, such as loans and mortgages.
These REITs either finance real estate transactions outright as loan originators or by purchasing existing mortgages from other loan-origination entities. The main source of profits for mortgage REITs is the interest that is collected on the mortgages and loans. Therefore, mortgage REITs are especially sensitive to interest rates fluctuations. Interest rate volatility and an inversion between short-term and long-term rates can substantially affect their income in any period.
Another type of equity that frequently offers monthly dividend distributions are business development companies (BDCs). BDCs are investment companies that primarily invest in medium, small and distressed businesses. In addition to the requirement to distribute at least 90% of their earnings to their shareholders like REITs, BDCs must also invest at least 70% of their total assets into private or public U.S. companies whose market value does not exceed $250 million.
Investors must be aware of the higher risk associated with BDCs because small and medium companies tend to carry above-average risk. However, the high payout ratios and leveraged positions are just some of the reasons why BDCs can offer monthly distributions and better-than average dividend yields.
Monthly dividend stocks offer many positive attributes that make them desirable to individual investors who are seeking a source of steady income, including investors who are either already retired or approaching retirement. However, these and all other investors who are interested in monthly dividend stocks must be aware of the speculative nature of monthly dividend stocks. Because these equities are required to distribute almost all of their earnings as dividend distributions, high dividend payout ratios allow very little margin for error.
A regular company can decide to hold back a portion of its earnings and accumulate those funds as cash on hand. These funds then are available to cover any unexpected expenses, cover operational costs if revenues decline or fund business expansion. However, REITs, BDCs and similar business entities do not have that luxury due to the 90% earnings distribution requirement for maintaining their tax-exempt status.
The tradeoff for the favorable tax treatment is the presence of more frequent distributions that compound faster and the higher yields that investors seek. However, because many monthly dividend stocks are more vulnerable and exposed to the negative effects of market downturns and recessions, investors must design their respective portfolio to limit downward exposure.
Just like with every investment decision, investors must evaluate the potential returns against any anticipated risks and diversify their portfolio across asset classes, business sectors and business entities. This approach requires forgoing some conveniences in exchange for lower risk exposure. While asset appreciation is a crucial step for building wealth over extended time horizons, all successful investors will agree that wealth protection is at least as important, if not more important, than wealth creation.
An income distributions schedule that meets one’s ongoing living expenses is certainly convenient. Monthly distributions certainly offer many advantages, including faster compounding, as long as those distributions are sustainable. However, a steadily rising and reliable quarterly dividend payout — even with a lower yield — is more beneficial than a high-yield monthly distribution that declines or disappears.
However, monthly dividend stocks have a place in every investment portfolio. The share of funds that are allocated to monthly dividend stocks might vary depending on the portfolio’s specific strategy. Finding the monthly dividend stocks that best match one’s portfolio strategy should be relatively easy. Most investment advisory sites and brokerages have a search or analytics tool designated for equities that pay monthly dividends. With a little research to identify the stocks that are best suited for a specific portfolio, every investor can enjoy the benefits of monthly dividend income distributions with minimal risk exposure.
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Ned Piplovic is the assistant editor of website content at Eagle Financial Publications. He graduated from Columbia University with a Bachelor’s degree in Economics and Philosophy. Prior to joining Eagle, Ned spent 15 years in corporate operations and financial management. Ned writes for www.DividendInvestor.com and www.StockInvestor.com.