Dollar cost averaging is a very simple, yet very effective approach to investing. Dollar cost averaging is a long term investing strategy that is implemented by investing a fixed amount of money into the same stock or fund over a period of time.
A common saying among investors in support of dollar cost averaging is “time in the market beats timing the market.” The idea behind this saying is that investing in the market over a long period of time will outperform attempts at trying to make perfect trades by buying at the lows and selling high. No one truly knows when the market is low or high. This means that you are losing opportunity by not being in the market sooner. The market is unpredictable and by using this method you greatly reduce your risk. Chances are, if you contribute to a 401k, 457b, 403b or similar employer sponsored retirement plan, you are already implementing a dollar cost averaging strategy, unless you are switching funds frequently.
How To Implement a Dollar Cost Averaging Strategy
There are typically a few ways that a dollar cost averaging strategy is used. As talked about previously, your retirement plan at work is likely dollar cost averaged. You contribute a certain amount into your 401k, for example, every week, bi-weekly or maybe even monthly. Another example would be maxing your Roth IRA each year with one lump sum contribution. This is dollar cost averaging on an annual basis rather than per pay period like your 401k might be, but the premise is the same.
Similarly, you may contribute to an individual account in which you manually invest money weekly, bi-weekly, monthly, etc. Assuming you put money into the same funds/stocks on a regular basis this is another form of dollar cost averaging. Even automatically reinvested dividends could be considered dollar cost averaging. This would typically be on a quarterly basis.
Another commonly used application is when one has a lump sum of money they want to invest. Rather than investing all the money at once, they will invest the money across periodic intervals. This tends to make people feel like they are lessening their risk, but as we will talk about later on it may be counterintuitive.
Dollar Cost Averaging: In Practice
Dollar cost averaging allows you to purchase more shares when the price is low and fewer shares when the price is high. This gives you an average price per share somewhere in the middle.
Let’s use our friend Tom as an example. Tom is a new investor and has decided to start investing on January 1st. Tom will invest $1,500 per month, on the first of each month, into an index fund called ABC. Looking forward six months, the price of ABC on January 1st is $50, February 1st – $54 dollars, March 1st – $42 dollars, April 1st – $45 dollars, May 1st – $46 dollars and on June 1st – $53 dollars.
Each month Tom’s $1,500 would have bought a different number of shares.This is due to the difference in share price.
To calculate how many shares Tom can purchase each month we will divide the amount invested by the price of the shares at the time. Here’s the math for January: $1,500 invested / shares of ABC at $50 each = 30 shares.
January – 30 shares, February – 27.78 shares, March – 35.71 shares, April – 33.33 shares, May – 32.61 shares and June – 28.30. After six months, Tom would own a total of 187.73 shares of ABC with an average cost of $47.94 per share ($9,000 invested / 187.73 total shares = $47.94). He invested a total of $9,000 that is now worth $9,949.69.
It is important to note that this example worked out favorably for Tom because of the overall increase in share price of our hypothetical fund called ABC. Dollar cost averaging does not reduce the risk associated with a market decline. It can though, potentially increase the performance of an investment, providing the price of the investment increases over time. This is why dollar cost averaging the entire market, or more likely a fund that tracks the market, which has historically gone up over time, is a popular strategy.
Potential Drawbacks
There are a few potential drawbacks to a dollar cost averaging strategy. The first potential drawback to dollar cost averaging is the possible loss of gains. For example, if Tom could have predicted the future and invested the entire $9,000 on March 1st when the shares were the lowest, he would have seen a $2,356.84 gain by June 1st. Conversely, if he had invested the entire $9,000 on February 1st when the shares were the highest, he would have seen a loss of $163.49. This drawback is only relevant if you are successfully able to buy and sell at the perfect time. Unfortunately, most of us don’t have the ability to see the future.
The next potential drawback is the potential for increased broker fees by making more trades. There are many low cost brokerages and more and more that offer free trades out there, making this much less of an issue than it once was.
Lastly, the reason that dollar cost averaging makes sense is the same reason that it might not. The idea is that the market will go up over time so buying over consistent time periods will allow you to capitalize on this. By not investing as much as you can, as soon as you can, you are, in theory, allowing the market to rise before investing more. This really only applies when dollar cost averaging a lump sum of money though. You can’t invest money that you don’t have.
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Generally, parents will make every attempt to give their children a better life than they had. This can be seen in all aspects of life whether it be home life, education, general wellness and our focus today, financial. Children on the other hand, typically don’t care too much for finances until they reach adolescence. At which point, many children become more independent. They start to understand that things cost money and that they don’t have any.
Luckily for them, being the great parent that you are, you’ve decided early on to start saving for them. You are now able to buy them a car and let them begin working and learn all of the invaluable lessons that come along with part time jobs. Maybe you’ve even saved enough to pay for them to go to college. And maybe you’ll have enough to help them purchase their first home.
Doing these things for your child opens the door for positive financial conversations. These positive financial conversations can spark an interest in your children that may benefit them for the rest of their lives.
What are my options?
There are a lot of ways you can start saving and investing for your children. Saving and investing is not a one size fits all operation, the goal of this post is to give you as many options as possible. As with most things investing, a long time horizon is ideal. Proper planning while your children are young will give them the best chance for positive investment returns. The chart below shows the growth of $1,000 – $15,000 earning a 7% return over the span of 5 – 25 years.
UTGA and UTMA Accounts
UTGA and UTMA accounts are custodial accounts named after the laws they’re based on. Uniform gifts to minors act and uniform transfers to minors act, respectively. Being custodial accounts, they are held in the name of a minor but controlled by a custodian (usually a parent or other relative) until the minor reaches an age of majority. The age of majority is designated by your state, typically between the age of 18 and 25 (sometimes referred to as the age of trust termination). Contributions made to these accounts are with after-tax dollars and are not tax deductible.
UTGA vs UTMA
The primary difference between these two types of accounts is the allowable assets for each. An UGMA account is the original custodial account and is limited to financial products such as stocks, mutual funds, bonds, cash, insurance policies, etc. An UTMA account can hold physical assets such as real estate, patents, cars, art and all of the same products that can be held in an UGMA account.
**Some states have not adopted the newer UTMA account and may not be available to you.**
Advantages:
The money contributed into the account is exempt from paying a gift tax, up to the 2021 maximum of $15,000.
The taxes owed on the first $1,050 of realized gains will be tax free. The next $1,050 will be taxed at the minor’s tax rate. The amount above $2,100 will be taxed based on kiddie unearned income tax rates.
The custodian may withdraw money at any time for the benefit of the minor. These benefits must be for costs other than food, shelter and clothing and may include expenses such as education, sporting activities and summer camps.
Easy and free to create an account when compared to a potentially more complicated and costly trust.
When the minor takes possession, the funds can be used for anything, not just education expenses (also a potential disadvantage).
Assets in these accounts may be protected from creditors and bankruptcy provided that the account has been used correctly.
Disadvantages:
These accounts are reported as a child’s asset when it comes time to apply for financial aid. The child’s aid eligibility will be reduced by 20% of the assets value.
Taxes will be owed on any realized income including dividends, interest, etc. (Up to 37% based on kiddie unearned income tax rates).
When the minor takes possession, the funds can be used for anything, not just education expenses (also a potential advantage).
The account will be part of the custodians taxable estate until the minor takes possession.
You cannot transfer the account to another minor or beneficiary.
Gifts in excess of $15,000 per year require a form to be completed for the IRS and must also be counted toward the individual’s lifetime gift-tax exclusion limits.
Child owned Roth IRA
A child owned Roth IRA is similar to a custodial account in that the decisions such as contributions, investments and distributions are made by a custodian until the child reaches the age of majority. At that point, the assets must be transferred to a new account in the child’s name. While this type of account has no age restriction, it does have income restrictions. Contributions are made to this account with after tax dollars and all growth within the account is tax free.
**A traditional IRA may also be opened for a child. A traditional IRA operates similarly to a Roth except money contributed to a traditional IRA is tax deductible. In this case, being a custodial account, the deduction will apply for the child, not the custodian. Because of this tax deduction, money withdrawn from a traditional IRA at retirement age will be subject to taxes. Contributions made to a traditional IRA are not able to be withdrawn tax and penalty free as they are with a Roth IRA. Withdrawals can be made for specified purposes such as first time home purchases, higher education costs and medical emergencies.**
Advantages:
Tax free growth within the account.
Contributions can be withdrawn at any time for any purpose.
Capital gains can be used to cover higher education costs, buying a first house or certain emergencies.
No minimum age requirement.
Retirement account balances are not included as assets on the FAFSA. Withdrawals from a retirement account need to be reported on the FAFSA as income from the prior year. If a distribution from a Roth IRA is made during a students sophomore year (high school or college), it will not be reported on the FAFSA since the income is reported from the prior year.
When the minor takes possession, the funds can be used for anything, not just education expenses (also a potential disadvantage).
Disadvantages:
Children must have earned income for the year. Contributions are limited to $6,000 (2021 limit) per year or the amount of earned income, whichever is less. This income can come from babysitting, lawn mowing, modeling, etc.
Capital gains withdrawn before age 59 ½ will be subject to a 10% early withdrawal penalty (exceptions apply).
When the minor takes possession, the funds can be used for anything, not just education expenses (also a potential advantage).
Roth / Traditional IRA
Rather than open a custodial IRA for your child, you can open one for yourself. All the same rules apply as a custodial account, except that the account will not transfer to a beneficiary at the age of majority.
Advantages:
Full control of how the money is used.
A way to save for yourself and children simultaneously.
Retirement account balances are not included as assets on the FAFSA. Withdrawals from a retirement account need to be reported on the FAFSA. If a distribution from a Roth IRA is made during a students sophomore year (high school or college assuming the student graduates in 4 years), it will not be reported on the FAFSA since the income is reported from the prior year.
If using a traditional IRA, contributions are tax deductible.
Disadvantages:
The money will not transfer to a beneficiary at the age of majority.
Required minimum distributions at age 72.
$6,000 annual contribution limit (2021).
529 College Savings Plan
529 plans were named after section 529 of the Internal Revenue Code. These are state sponsored plans but you are not limited to invest just in your state’s plan. Generally speaking, you could live in New York, invest in a Texas 529 plan and send your child to school in North Carolina. There is somewhere around 6,000 colleges and 400 foreign colleges that accept 529 plans. Contributions made to a 529 plan are made with after tax dollars. Some states do offer income tax deductions or tax credits, you may need to invest in your home state’s 529 to claim the benefit though. Funds grow tax free inside the account and are also tax free when withdrawn for qualified education costs.
Advantages:
Tax free growth and withdrawals for education expenses. Qualified withdrawals may include tuition and fees, books and materials, room and board (for students enrolled at least half-time), computers and related equipment, internet access and special needs equipment.
Up to $10,000 per year, per beneficiary may be used to pay for K-12 tuition expenses, tax free.
Up to $10,000 (lifetime limit) for the beneficiary (and siblings) for student loan repayments, tax free.
The beneficiary can be changed to another child or another qualified family member.
Parental assets reduce financial aid by up to 5.64% vs. up to 20% of student owned assets.
The owner of the account retains control and is not transferred to the beneficiary.
Similar to a Roth IRA, contributions may be withdrawn tax and penalty free.
Disadvantages:
Non-qualified withdrawals are subject to tax and a 10% penalty.
Some plans have required minimum initial contributions.
A roll-over from one state’s plan to another may subject any income tax deductions or credits to recapture.
Limited investment options within the account, sometimes accompanied with high fees.
529 Prepaid Plan
These accounts are similar to 529 savings plans with some key distinctions. The major difference is that they are, like the name suggests, prepaid. The owner of the account will purchase tuition in the form of years, credits or units in a lump sum or installment payments.
Advantages:
The ability to lock in tuition costs at current rates.
Most states guarantee the funds in these accounts will keep pace with inflation.
Disadvantages:
A prepaid plan will typically only cover tuition and fees.
Some states have specific enrollment periods throughout the year.
Coverdell Education Savings Account (ESA)
These accounts are similar to 529 savings plans in that contributions are made with after tax dollars, money grows tax free within the account and withdrawals made for qualified education expenses are tax free. The major difference between these accounts are the contribution and income limits as well as the investment flexibility that an ESA provides.
Advantages:
Virtually limitless investment options.
Tax free growth and withdrawals for education expenses. Qualified withdrawals may include tuition and fees, books and materials, room and board (for students enrolled at least half-time), computers and related equipment, internet access and special needs equipment.
The funds may be rolled over into another ESA for another eligible family member.
Parental assets reduce financial aid by up to 5.64% vs. up to 20% of student owned assets.
Funds may be used for K-12 education expenses.
Disadvantages:
Contributions cannot be made after the beneficiary reaches age 18 without paying a 6% excise tax.
Annual contribution limit of $2,000 (2021).
The account must be fully withdrawn by the time the beneficiary reaches age 30 or the account may be subject to tax and penalties.
You can’t contribute to an ESA if you make more than $110,000 (single) or $220,000 (married filing jointly) (2021). Phase out limits start at $95,000 and $190,000, respectively.
Non-qualified withdrawals will be subject to tax and penalty.
Trust Funds
A trust fund is an estate planning tool that holds and manages assets on behalf of a person or organization, managed by a neutral third party. The grantor establishes the trust fund and the beneficiary is who will receive the assets. A trustee will oversee and fulfill any responsibilities outlined by the grantor as well as handle distributions to the beneficiary. A trust lets you pass assets to someone in a structured way. This allows you to set specific rules for when the beneficiary can access the assets and how they are able to utilize them.
Advantages:
Can hold basically anything within a trust: cash, stocks, bonds, houses, businesses, artwork, etc.
Ability to pass assets to specific people in specific ways.
Beneficiaries do not have to pay taxes on distributions received from a trust.
A trust can allow your family to avoid probate court. This also keeps your personal wishes private.
Disadvantages:
Trusts can get complicated and expensive to put into place.
Trusts reduce need-based financial aid eligibility by 20 percent of the assets value. These accounts are reported as a child’s asset when it comes time to apply for financial aid, even if access to the assets is restricted (there can be some exceptions to this rule such as court ordered restrictions).
The assets in a trust are no longer yours. The trustee(s) will control the assets within the trust.
Home Equity Loan
Home equity is the difference between the appraised value of your home and how much you owe on the home. A home equity loan is a way to get a fixed rate loan based on this equity. Home equity loans are received as a lump sum in the amount of the loan and you can use the money for whatever you choose.
** Similar to home equity loans, home equity lines of credit (HELOC) can be used in a similar manner. HELOCs differ in that they function as a revolving line of credit. They also have variable interest rates. You will typically have 10 years to draw from the loan (draw period) and then 20 years to pay it back (repayment period).**
Advantages
Fixed rates provide predictable payments typically with lower interest rates than other loan types.
Repayment terms can be from 5 to 30 years.
Home equity is not a factor in determining financial aid.
Disadvantages
If you sell your home before the home equity loan is paid back, the remaining balance will be due.
Home equity loans usually come with closing costs and fees that typically amount to 2-5% of the loan amount.
A home equity loan uses your home as collateral, late or missed payments could put your home in jeopardy.
Employer Sponsored Retirement Plan (401k/403b/457b)
These types of investment plans are offered by employers to provide employees an option to save for retirement. With these plans, the employees shoulder all the risk. Some employers will offer to match employer contributions up to a specific percentage of their salaries. These accounts are funded with pre-tax dollars and are subject to tax when distributions are made.
It is important to note that there are differences between 401k’s, 403b’s and 457b’s so be sure to know the rules of your specific plan before making a savings plan.
**Some employers will offer a Roth version of these retirement account as well. Roth 401k’s, 403b’s and 457b’s all operate similar to a Roth IRA (as discussed above) in that the money is funded with post-tax dollars and distributions are tax free.**
**Health savings accounts (HSA) are tax advantaged accounts that are available to individuals who are enrolled in a qualified high deductible insurance plan. They may be employer sponsored but may also be opened on your own. Receipts saved from unreimbursed medical expenses can be used to get tax free funds from your HSA that can be used for any purpose, even years after the expenses were incurred.**
Advantages
High annual contribution limits. For 2021 the limit is $19,500, $26,000 if 50 or older.
Opportunity for free money if your employer provides a match.
Tax deferred growth until the time of distribution. Contributions reduce current taxable income.
Funds in employer sponsored plans are protected from creditors in most cases.
Retirement account balances are not included as assets on the FAFSA. Withdrawals from a retirement account need to be reported on the FAFSA.
Many retirement plan sponsors offer loan options on your account balance.
Disadvantages
Early withdrawals (generally before age 59 1/2) will be subject to a 10% penalty as well as taxes.
Often have limited investment options.
May be accompanied by higher fees.
Required minimum distributions at age 72.
Individual Brokerage Account
A brokerage account is a type of investment account that is often referred to as a taxable account. This is because contributions are made with after tax dollars and taxes are owed on realized gains within the account as well.
Advantages
No contribution limits.
Access to funds without penalty.
Tax loss harvesting is possible (the ability to offset $3,000 of ordinary income with $3,000 of realized investment losses).
Virtually limitless investment options.
Parental assets reduce financial aid by up to 5.64% vs. up to 20% of student owned assets.
No required minimum distributions.
Disadvantages
No tax advantages.
Brokers may charge a commission for each trade made.
Whole Life Insurance
Permanent life insurance combines a death benefit with a savings portion. A portion of the fixed premium goes towards the death benefit and another portions goes towards savings, which can earn interest and grow. These types of life insurance plans are not for a set term. Instead, they last for the lifetime of the insured so long as premiums are paid. The two main types of permanent life insurance are whole life and universal life. Others include variable life and variable universal life.
Advantages
Withdrawals up to the total amount paid in premiums can usually be made tax free.
Growth of the cash value within these accounts are generally on a tax deferred basis.
The death benefit is generally passed to the beneficiary tax free.
You are able to take loans out on the cash value of your policy. This loan does not need to be paid back but, the policy’s death benefit will be reduced accordingly. You will also pay interest on this loan.
Cash value policies will not count as assets when filling out the FAFSA.
Disadvantages
Whole life policies are expensive and often loaded with fees. These fees and salesperson commissions are often very non-transparent.
If it is the insurance aspect that interests you, a term life policy can provide a much higher death benefit at a much lower cost.
The insurance company controls how your cash value portion is invested, not you.
It takes a long time to see positive returns, making it impossible to get back the money you put in.
If you decide to cancel your policy, you will likely have to pay a surrender charge and pay tax on any earnings.
Certificates of Deposit
A Certificate of Deposit, also known as a CD, is a low-risk savings tool that is offered by banks. Share certificates are an identical tool but instead offered by credit unions. We will use CDs to refer to both of these tools going forward.
CDs are offered in fixed length terms. The most common CD terms are 3 months, 6 months, 9 months, 1 year, 2 years, 3 years, 4 years and 5 years. At the end of the fixed term is a designated withdrawal date, known as the maturity date. On the maturity date you will have access to your original investment, known as the principal, as well as any interest that has accrued over the length of the term.
Different banks and credit unions will offer different rates and terms so it can be beneficial to shop around. You may find the best rates during promotional periods, so keep an eye out for those.
Advantages:
Fixed, predictable return in a predetermined amount of time.
Returns without much risk. FDIC or NCUA insured up to $250,000.
Useful to protect savings designated toward specific purchases.
Parental assets reduce financial aid by up to 5.64% vs. up to 20% of student owned assets.
Easy to open, comparable to opening a savings account.
Can help reduce the urge to tap into savings to spend since you will likely incur an early withdrawal penalty.
Disadvantages:
Do not have regular access to your money and will incur early withdrawal penalties, though you may be able to withdraw interest payments.
Low potential return on investment.
The initial deposit made into the CD will be the only deposit, you cannot add more, rather you would need to open a new CD.
CDs may automatically renew for the same original term if money is not withdrawn within the grace period, usually about a week.
Fixed rate of return even if interest rates rise during the term.
Bonds
Unlike a stock that provides ownership rights to a company, a bond is a loan from you to the issuer of the bond. Bonds can be issued by companies or governments. Bonds issued by companies are called corporate bonds, federal government issued bonds are called treasury bonds and bonds issued by non-federal governmental entities such as states, cities and counties are called municipal bonds. Bonds pay a fixed rate of return over a specific period of time. Riskier bonds tend to pay a higher interest rate while less risky bonds pay a lower interest rate.
Advantages
Low volatility when compared with stocks.
With fixed interest rates you know exactly what your return will be.
Bonds issued by the U.S. Treasury and larger corporations are generally very liquid.
Bonds are universally rated by credit agencies such as Moody’s.
Disadvantages
The value of bonds are subject to interest rate risk. This may not be an issue if you plan to collect interest payments and hold the bond to maturity.
Some bonds can be illiquid, such as those issued by smaller companies or bonds with a higher face value.
Inflation can erode the buying power of fixed interest payments over time.
Companies can default on your bonds.
High Yield Savings Account
A high yield savings account is nearly identical to a traditional savings account. As the name suggests, these accounts offer a higher APY (annual percentage yield) than a traditional savings account. These accounts are also typically offered by internet-only banks, but this may not always be the case. These accounts are FDIC or NCUA insured.
** In the same realm as high yield savings accounts are money market accounts. It is similar to a HYSA (high yield savings account) but with checking account features and typically limit withdrawals made per month. They are also FDIC or NCUA insured.**
Advantages
Returns without much risk. FDIC or NCUA insured up to $250,000.
Interest compounds daily.
Parental assets reduce financial aid by up to 5.64% vs. up to 20% of student owned assets.
Useful to protect savings designated toward specific purchases.
Generally pretty easy to open an account (read all the details to avoid any fees).
Easy to transfer money between accounts online.
Disadvantages
The APY can and will fluctuate when the Federal Reserve adjusts its benchmark rate.
It can take a few days to get access to physical cash. You will often need a local bank to withdraw cash from and wait for online transactions to process (some HYSA’s do offer ATM cards).
Some accounts require minimum direct deposits, minimum balances and may charge fees.
Low potential return on investment.
You are limited to six withdrawals per month before facing fees or account closure (this could also be an advantage to help prevent you from pulling from your savings).
There may a cap on the amount of money that will earn the higher APY and anything past that may earn a rate congruent with a traditional savings account (you could open multiple HYSA’s with different banks to side step this).
Money Market Fund
Money market funds are different than money market accounts. Money market accounts are more like savings accounts, while money market funds are a kind of mutual fund. They invest in highly liquid, low risk securities, cash, cash equivalents, CD’s, U.S. Treasuries, etc. These funds are offered by financial institutions and are regulated by the SEC. These accounts are not FDIC or NCUA insured so you could lose your principal.
Advantages
Same day settlement, no transaction limits.
Low risk, but not zero risk.
Parental assets reduce financial aid by up to 5.64% vs. up to 20% of student owned assets.
Highly liquid, can be valuable for short term savings.
No minimum investment requirement.
The rates will adjust with the market as opposed to a fixed rate investment.
Disadvantages
No FDIC or NCUA insurance.
Low potential return on investment.
Some accounts have expensive fees.
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Disclosure: This post is sponsored by SMBX. As always, all opinions and ideas are entirely my own.
Update: 3/17/21
I received an email response within 24 hours solving my issue. I’m not sure exactly what they did to fix, but there was some kind of technical error. Thumbs up for the SMBX customer service. Now that my bank account is linked to my account I’m able to purchase bonds. I planned to buy 5 different bonds for $10 each, but each of these purchases would require 5 transactions from my bank account. My bank account charges me for each transaction past 6 per month. I would prefer an option to fund my SMBX account rather than needing to purchase bonds directly from my bank account. Instead of 5 bonds at $10 each, I purchased 5 bonds of Humphry Slocombe for $50. There are 15 days until the offering closes so I will need to wait until then and assuming funding is met, wait about another month until I receive any interest. No transaction fees is always a plus.
Update: 3/16/21
I received the two micro deposits into my bank account. Unfortunately, there is no area to confirm these deposits on the site. I sent SMBX an email to see if I’m missing something or if there is an error.
I have recently been made aware of a pretty cool new investment opportunity. Very recently, actually. I haven’t even been able to start investing yet. I’m waiting for micro deposits to hit my back account so I can start purchasing. If this platform grows to what I believe it can, it could be huge and I figured I needed to share this with all of you sooner rather than later. My plan is to update this post as I make purchases, receive payments and get solid, boots on the ground, first hand experience with this platform that I’ll be able to share in real-time.
So, What Is It?
It all started back in 2016 when Title III of the JOBS Act was enacted by the Securities and Exchange Commission. Long story short, this allowed investing in small businesses and startups to become much easier. Thus, SMBX was born.
The mission of SMBX is simple: connect investors with successful small business owners by utilizing their bond marketplace. Yes, small business bonds. The ability to issue bonds used to be restricted to governments and large corporations, until now.
As a small business owner this provides many unique benefits. First, SMBX makes it easy by filing the necessary paperwork for you after you review it. Second, SMBX is able to provide a low fee structure by avoiding fees that are typically associated with banks and other lending platforms. Lastly, the SMBX bond marketplace is a unique place that allows a business to build their brand, engage existing customers and acquire new customers.
Now, the side that I’m most interested in and will be testing. The investor side. As an investor, you have the ability to browse a variety of small businesses looking for investors. Information like the businesses story, the owners story and the use of funds are highlighted on the offering page. Relevant investment information like minimum raise, maximum raise, bond duration, yield and if the bonds are secured against collateral is also front and center on the offering page. The ability to view and download the bond prospectus or a summary and the issuers financial statement is available on the offering page as well.
What I’m Excited About
First, I’m excited to get started with this platform. I have experience with some peer to peer lending platforms. I had some success with them and my only real complaint was the amount of risk it took to achieve a worthwhile yield. This led to more defaults than I liked and is what ultimately drove me away from these platforms. A healthy return is my primary focus as an investor but, I want to achieve this with as little risk as possible. The best investment to me is the one with the highest return and lowest risk.
SMBX offers yields as high as 9%, with as little as $10 invested, once the offering has closed interest and principal is paid in equal monthly payments. For comparison, my favorite bond ETF, Vanguard Total Bond Market Index Fund (BND), is yielding 2.58% at the time of this writing. A yield of 9% in the stock market is often indicative of a high payout ratio and is generally seen as unsustainable. Naturally, this opportunity piqued my interest.
Second, I like that it’s quick and easy to learn about the small business and potential returns. If I imagine a scenario where a local small business approached me looking for an investment, I would almost feel bad asking as many questions as I would need to before committing to investing. On the SMBX platform, all the information that I need is plainly laid out on the businesses offering page. If I do have additional questions, I can leave a comment directly on the offering page that can be answered by the owner of the small business.
I believe in shopping local and supporting small businesses. As a small business owner, I know how difficult it can be at times, especially given the current state of the country due to the Covid-19 pandemic. I like that the SMBX platform allows me to “shop locally” from small businesses that are not geographically local to me. This allows the ability to support businesses and causes that I believe in, while also earning money. There is something satisfying about knowing that my investment will make a difference.
What I’d Like To See Going Forward
First and foremost, being brand new to the platform, I would like to see interest and principal payments hitting my account. I should get my first payments in about a month. When I do, I’ll update this post with that process and anything else I’ve learned about the platform in that time.
The current funding options are credit card and bank account. I really like the idea of being able to fund my account with my credit card. I’m a big fan of credit card cash back and rewards. Unfortunately, you will incur a 4% fee when funding with a credit card. I’m not willing to pay a 4% fee to use my credit card. That just leaves using a bank account, which is fine, but I’d like to see a more modern solution. Paypal, Venmo, Cash App or just the ability to use a credit card without a fee.
I would also like to see more investment options going forward. I imagine this will become reality as the platform gains more traction. I also don’t really care to see completed offerings. I’m not able to invest in these offerings so it’s just a distraction from offerings that I am able to invest in.
I’m a Samsung (Android) smartphone user. Currently, SMBX only has an iOS app, I’d like to see an Android app. I do most things on my phone, that included signing up for SMBX. The process on my smartphone internet browser was a bit clumsy. I have an apostrophe in my last name and I wasn’t able to sign up using one. While entering my birthday I had to click a little arrow on a calendar to move one month at a time about 330 times to get from present day to my birth year. Fortunately for me, I’ll never need to do that again now that my account is setup, but it would be nice to see that corrected for new users. I imagine that’s not an issue using the iOS app or a computer, please feel free to leave a comment below if you sign up with one of those methods and can confirm one way or the other.
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I use Personal Capital to track my net worth. It’s phenomenal, honestly. I login almost daily to keep an eye on things. If you want to check it out, use my link to sign-up here. (It’s free)
Many investors are likely familiar with the phrase “buy and hold”. These three words imply that investors should simply buy shares of companies and then hold them through the inevitable ups and downs of the economic cycle. Many believe that this investing strategy could lead to enough wealth creation to last the length of one’s retirement and maybe even allow investors to leave something to their heirs.
In order for this time-tested strategy to succeed, investors must choose sound investments to start with. Investing in low quality stocks and then stubbornly holding on to them when they decline in value likely isn’t a good way to achieve your goals. On the other hand, high-quality stocks have the best chances of providing steady dividend growth and rising passive income.
What is Passive Income?
Passive income can be thought of as money you earn while committing minimal daily effort to maintain. This is different than money you make from your profession. Income from your job can be used to create a retirement portfolio that provides passive income. We believe that the best way for investors to achieve a steady stream of passive income is by purchasing shares of companies that have paid a growing dividend for multiple decades.
In their infancy, publicly traded companies often reinvest every dollar of profit back into the business. Companies in this stage are often experiencing high rates of growth and need all available capital on hand to ensure that they can continue to expand their business and take market share from peers.
Eventually, growth rates decline in many cases, usually because the company has become so large that sustaining high rates of growth becomes harder. Companies in this stage are much more stable, having created a stable customer base or some measure of importance in their given sector of the economy. This quite often leads to increased profitability.
Companies that have raised their dividends through one or more recession have proven that their business model is strong enough to withstand downturns. Past performance does not equate to future success, but a history of growing dividends through adverse economic conditions is a sign of a well-run business.
In our opinion, an excellent place to look for blue chip dividend paying stocks is the Dividend Aristocrat list. Companies that qualify as a Dividend Aristocrat have increased dividends for at least 25 consecutive years, are a member of the S&P 500 index and meet certain size and liquidity requirements.
Membership in this list is so exclusive that just 65 companies currently qualify as a Dividend Aristocrat, showing how difficult it is for companies to achieve the required dividend growth streak.
3 Dividend Stocks For Safe Passive Income
AT&T Inc. (T) has a rich history, dating all the way back to Alexander Graham Bell and the original telephone in the late-1800’s. AT&T isn’t just a phone company though. Today, the company is the largest communications company in the world. Besides offering phone service to customers, AT&T also provides video, broadband, pay-TV and movies.
AT&T is very much a slow growing company these days as earnings-per-share have increased by less than 4% annually since 2011.
That said, the company’s move away from just being a phone company has offered some diversification. The purchase of Time Warner in 2018 gave it an excellent portfolio of content. For example, AT&T recently launch its HBO Max streaming service and had almost 40 million subscribers at the end of January. This is two years ahead of the company’s own expectations.
AT&T is blessed with impressive free cash flow (more than $27.5 billion in 2020). This has allowed the company to more than cover its generous dividend yield of 7%, which is almost five times the average yield of the S&P 500. The company had a free cash flow and earnings-per-share payout ratio of 62% and 65%, respectively, last year, showing that the company is fully capable of supporting its robust dividend. AT&T has raised its dividend for 36 consecutive years.
Another high quality dividend stock is Johnson & Johnson (JNJ), one of the largest companies in the world and a leading healthcare company. The company provides pharmaceuticals, medical devices and consumers products. Johnson & Johnson’s diversified business model allows it access to nearly every area of the healthcare sector.
The company’s business has climbed steadily, with earnings-per-share growing at a 5% clip over the last decade. However, the COVID-19 pandemic was a headwind to results, reducing the decade long growth average by a full percentage point.
Even with the pandemic impacting results, Johnson & Johnson still raised its dividend in 2020, something it has done for 58 consecutive years. This also qualifies Johnson & Johnson as a Dividend King. The company has one of the longest dividend growth streaks in the entire market place and offers a yield of 2.6% today. The earnings payout ratio was just 50% last year and is expected to be just 43% this year, showing that Johnson & Johnson has prudentially managed its dividend growth.
Lastly, Procter & Gamble (PG) is a consumer products giant that sell its products in more than 190 countries. Its core brands include, Gillette, Tide, Charmin, Crest, Pampers, Bounty and Head & Shoulders.
Procter & Gamble has undertaken a drastic scale down over the past few years and has divested non-core assets. The company has a portfolio of 65 brands, down from 170 just a few years ago. Procter & Gamble now has five product categories: fabric and home care, baby, feminine and family care, beauty, health care and grooming, with no one category accounting for more than one-third of total sales.
Having a leadership position in nearly every category that it competes has afforded Procter & Gamble brand loyalty amongst its customer base. Customers trust the products that the company provides, which allows for some pricing power as well.
Brand loyalty is one reason why Procter & Gamble has been able to grow its dividend distribution for 64 years. Few companies have raised their dividend for a longer period of time. Procter & Gamble yields 2.5% and has an expected earnings payout ratio of 56% for 2021.
Final Thoughts
We believe investors can create a retirement portfolio that can provide passive income simply by knowing where to look. The Dividend Aristocrats are a great place to begin the search for passive income as these companies have demonstrated the ability to raise their dividends for at least 25 consecutive years.
An increasing dividend during difficult economic periods is a sign of strength. AT&T, Johnson & Johnson and Procter & Gamble have each accomplished this feat on several occasions. All three companies offer products or services that consumers have come to trust and rely on, even during uncertain times. This has allowed each company to grow dividends even during recessions. Any investor looking to create passive income could do very well owning each of these names.
Written by Nate Parsh for Sure Dividend
Author disclosure: the author maintains a long position in AT&T, Johnson & Johnson and Procter & Gamble.
Disclosure: We may receive a referral fee if you sign up with a service through a link on this page.
I use Personal Capital to track my net worth. It’s phenomenal, honestly. I login almost daily to keep an eye on things. If you want to check it out, use my link to sign-up here. (It’s free)
There are many different investing paths to choose from like day trading, options trading, swing trading, value investing, growth investing and lots of others. For myself and many others, including Warren Buffet whose portfolio is roughly 90% dividend stocks, dividend growth investing is a style that we like to incorporate. Before we jump into dividends and dividend growth investing it’s important to understand a few things that are involved.
What Are Dividends?
A dividend is an amount of money that is paid by a company to its shareholders. An investor will receive a specified amount of money for each share that they own. For example, if you own 10 shares of Company A who announces a $1.00 dividend you will receive $10.00 on the date specified. Dividends are usually paid on a quarterly basis but they can also be paid monthly or semi-annually. Dividend payments can range anywhere from less than 1% to upwards of 20% of the share price. Though, companies that have a high dividend yield may not be able to sustain such a payment, choosing stocks solely on their dividend yield is extremely risky and not advised.
Three Types Of Dividends
There are three types of dividend payments you may receive, cash, stock and extraordinary. The most common type, a cash dividend is simply what it states, a payment from a company in the form of cash. A stock dividend is similar to a cash dividend except instead of paying shareholders with cash, they are paid with partial or whole shares of the company’s stock. An extraordinary dividend is a one time distribution of cash or stock to shareholders. This is also referred to as a “special dividend.” These dividends usually occur if a company makes an exceptional profit during a quarter or period.
Record Date and Ex-Dividend Date
The record date is the date announced by a company to determine which shareholders are eligible to receive a dividend. The ex-dividend date is usually set two days before the record date and it is the date in which you must own shares of a company in order to receive a dividend. If you purchase a stock on its ex-dividend date or after, you won’t be eligible to receive the most recently declared dividend. As long as you own a stock on the ex-dividend date you’re entitled to the dividend payout even if you sell your shares after the ex-dividend date. Buying a stock before its ex-dividend date and then selling after (but before the dividend payment date) and still receiving the dividend is called the dividend capture strategy.
Tax Advantages
It is important to know that long term capital gains are taxed differently than short term gains or ordinary income. A long term investment is one that has been held for longer than one year. The personal income tax rate is usually significantly higher than the long term investment tax rate, as you can see by the chart. Long term investments can save you big come tax time and that’s one of the biggest benefits of dividend growth investing. Disclaimer: Non-qualified dividends come from REITs, MLPs, tax-exempt corporations, and foreign corporations. These non-qualified dividends are taxed at your personal tax rate rather than the long term investment rate.
Dividend Aristocrats and Dividend Kings
Aristocrats and Kings are a great place to begin researching stocks for your own dividend growth portfolio. Dividend Aristocrats are companies within the S&P 500 that have been paying an increasing dividend for at least 25 consecutive years. Dividend Kings are companies within the S&P 500 that have been paying an increasing dividend for at least 50 consecutive years. It is important to note that since 1930 roughly 40% of the total U.S. stock market returns have come from dividends.
What Is Dividend Growth Investing?
Dividend growth investing is a form of investing that focuses on dividend growth, obviously right? Obvious indeed, but the uniqueness of this style of investing is what is so intriguing. Let’s go back to the previous example with 10 shares of Company A. They were paying a $1.00 per share dividend. Assuming Company A increased their dividend by 5% for 10 years, the initial $10.00 received in dividends would have grown to $16.30. You didn’t have to invest any additional principal to receive the extra dividends and you likely would have seen share price growth as well. This is a small scale example for simplicity sake but it properly illustrates the premise of dividend growth investing. This is the unique compounding effect of dividend growth investing.
Long Term Approach and DRIP
A dividend growth strategy is a long term approach to investing. There are many benefits to this, including the tax benefits we talked about earlier. You can also plan on paying less in broker fees because you’ll be buying and selling much less frequently. Historically, dividend stocks tend to do much better than their non-dividend paying counterparts during a down market as well. In a dividend growth approach, a pull-back in the market usually means discounted stock prices and a prime buying opportunity.
When you sign up with a broker you usually have the option to enroll in a dividend reinvestment plan (DRIP). This means that when you receive a dividend payment it will automatically be used to purchase fractional or whole shares of the company that paid you the dividend. The alternative is that your cash will sit in your account until you manually reinvest it or withdraw it.
A DRIP can be advantageous as time is always a factor, but there is another option to consider as well. For example, you receive a dividend from a company whose stock price is at an all time high. Is it really the best time to invest more money into that company? Maybe it is, maybe it isn’t. There’s really no way to know for sure, but an alternative to this method is to receive your dividend payments and manually redistribute them into stocks that are valued better at that time. It does take more work but, the payoff can certainly make it worth it.
Consistent Income
Another advantage to dividend growth investing is the income. With a non-dividend paying stock you only have one way to make or lose money, capital gains or capital losses. Thus, the only way to receive money that you can use is to sell your shares for a capital gain. You will receive dividends without having to sell shares making it easy to get some money out of the market.
How To Calculate Yield
It’s fairly simple to calculate dividend yield once you get the hang of it. The yield of a stock is the return paid over one year. For a dividend stock that pays quarterly, the yield is the sum of the last four quarterly dividends, divided by the price of the stock, multiplied by 100. For example, let ‘s say you buy AT&T (T) at $42.00 per share. And the last four quarterly dividends have been $0.48, $0.48, $0.48 and $0.48 giving a total of $1.92 per share. 1.92/42 = 0.04571429. Multiplied by 100 gives you a 4.57% yield.
How To Pick Dividend Stocks
You can use lots of different methods to pick dividend paying stocks. Here are four common methods to evaluate dividend stocks. Free cash flow to equity, dividend payout ratio, dividend coverage ratio and the net debt to EBITDA ratio. Together they combine to form a solid method for picking dividend stocks to purchase. However, there are other factors to consider as well such as current price and market conditions.
Some Things To Be Aware Of
Be aware that companies do not have to continue to pay dividends and they can be cut at any time. In economic hardships, dividends are usually the first thing to go, or at least the first thing to be trimmed. This is probably the biggest risk involved with dividend growth investing. This highlights why chasing yield can be dangerous. High yield is appealing and for good reason, but it’s far from safe. If you plan on investing in a company that pays a high yield do your due diligence. Properly value that company to be sure that dividend is sustainable. Also be aware that in a rising interest rate environment, dividend paying stocks may drop in price. People will often turn to other investment options such as CDs or bonds.
The appeal to invest in dividend paying stocks can be quite high. Receiving regular dividend payments can be enticing, especially to a new investor. I like to think that most new investors don’t know exactly where to begin but, they do want to make sure they are making good, informed purchases. With all the different dividend paying stocks out there it can be challenging to decide which of these will be the best fit for your portfolio.
It is common for new dividend investors to be lured into purchasing a company based on a high yield. However, an extremely high yield often signals signs of unsustainability. Dividend sustainability is arguably the most important factor when deciding on which stocks to buy, especially for those looking for long term investments. If the company tanks and you lose all your money, it doesn’t matter how great the dividend was. Analyzing a company’s financials is crucial when determining which stocks to buy. Four major things to look at are; free cash flow to equity (FCFE), the dividend payout ratio, the dividend coverage ratio and the net debt to earnings before interest, taxes, depreciation and amortization (EBITDA ratio).
Free Cash Flow To Equity (FCFE)
Free cash flow to equity is measured by subtracting all expenses, reinvestments, debt repayments from net income and adding net debt. This calculation determines how much cash can be paid out to shareholders. Dividends and FCFE are not the same thing though. FCFE is simply what is available to be paid to shareholders, a dividend is the amount that is actually paid to shareholders. Investors usually want to see that the company’s entire dividend payments can be covered by the free cash flow to equity.
Dividend Payout Ratio
The dividend payout ratio indicates what portion of a company’s annual earnings per share is being paid in the form of dividends per share. The dividend payout ratio can be calculated by taking annual dividends per share (DPS) dividend by earnings per share (EPS). You can also calculate the dividend payout ratio by taking the total dividends paid divided by net income. The “magic” number here is 50%. A company that pays out more than 50% of its earnings in the form of dividends is generally considered less stable and at a greater risk to cut dividends, or increase dividends at a lower rate. A company that pays out less than 50% of its earnings in the form of dividends is generally considered stable and has more potential to raise dividends and maintain dividends over the long term.
Dividend Coverage Ratio
The dividend coverage ratio is used to determine the number of times that a company could pay dividends to its shareholders using its net income. It is used to evaluate the risk of not receiving dividends. To calculate the dividend coverage ratio take a companies annual earnings per share divided by its annual dividends per share. A higher dividend coverage ratio is preferred (higher than one), this means the company can pay dividends to its shareholders more times based on its net income. If a dividend coverage ratio is lower than one it may mean that the company is borrowing money to pay dividends.
Net Debt To EBITDA Ratio
The net debt to EBITDA ratio is used to determine a company’s leverage and its ability to pay its debt. To calculate a company’s net debt to EBITDA ratio take the company’s total liabilities minus cash divided by its EBITDA. A company with a lower net debt to EBITDA ratio is generally seen as more attractive when compared against other similar companies. Beware of dividend paying companies that have high net debt to EBITDA ratios and have been consistently increasing, this may be a sign of an upcoming dividend cut.
By utilizing and understanding these measures can help make informed decisions while picking which dividend stocks to buy next. Buying stock in companies that you understand is critical and will ultimately lead to greater success for your investments.
What strategy do you use to pick your dividend stocks?
Wouldn’t it be great if you could just collect dividends without suffering the volatility that comes along with stock ownership? The dividend capture strategy aims to do exactly that. The basis of the strategy is to hold a stock just long enough to receive the dividend. Fundamentally, it is an easy strategy to apply but it could be considered a gamble in practice.
The Basics
It is important to understand a few basic concepts before attempting to implement the dividend capture strategy. Firstly, dividends are a portion of a company’s profits that are paid regularly to shareholders. They are usually paid quarterly but they could also be paid monthly. Many investors rely on dividend growth companies as a source of income due to low volatility, low to moderate risk and competitive yields. The dividend capture strategy can be especially useful when a less attractive company pays a very attractive dividend. Thus allowing one to capture the generous dividend without assuming the risk of holding the company for any longer than required.
Dividend Dates
It is important to understand dividend dates to successfully implement this strategy. The important dates to understand are the declaration date, ex- dividend date, record date and the pay date.
Declaration date – This is the date in which the board of directors declares when the dividend will be paid and how much the dividend will be.
Ex-dividend date – This is the date in which investors must buy the stock before to receive the dividend. This is also the date in which the stock is supposed to be reduced by the dividend amount.
Record date – This is the date in which a company reviews its records to determine which shareholders are eligible to receive the dividend.
Pay date – This is the date in which shareholders will actually receive the dividend.
How It Works
Simply, buy a stock before the ex-dividend date and sell on or sometime after that date. After you have owned the stock on the ex-dividend date you no longer need to own the stock to receive the dividend. In theory, when a company pays a dividend the stock will drop by the amount of the dividend. In reality, there are three possible scenarios. These three scenarios will result in a loss, gain or breakeven outcome for the shareholder.
Loss – Company 1 is trading at $30 per share and declares a $0.50 dividend. The stock is purchased before the ex-dividend date and on the ex-date it drops down to $29 per share. This would result in a loss of $0.50 per share, the difference between the $1 loss per share of the stock and the $0.50 dividend.
Break even – Assuming the same scenario, Company 1 drops to $29.50 on the ex-date. This would result in a break even situation, no gain or loss. $0.50 loss per share recouped by the $0.50 dividend.
Gain – Assuming the same scenario, Company 1 stays at $30 per share on the ex-date. This would result in a gain of $0.50 per share. Stock price stayed the same with a $0.50 dividend.
The dividend capture situation aims to take advantage of the third scenario. Since it could go either way there is a certain amount of risk involved with this strategy.
Precautions
Before going out and trying to implement this strategy there are some things you should consider first. Taxes, brokerage fees and other market factors can be detrimental to profits.
Taxes – There are certain tax advantages for holding stocks long-term. Ordinary income tax will be owed on all the gains received from this method.
Brokerage fees – If you have a broker that charges per trade you’ll need to factor in the price of two trades. If your broker charges $5 per trade you’ll need to make an extra $10 to cover your buying and selling fees.
Market factors – There are an infinite number of factors that could affect the stocks price come the ex-dividend date. Acquisitions, law suits, interest rates, political factors, etc.
Lots of us read the stories about early retirees and turn green with envy. Many people don’t understand how to get to that point or how much money it really takes. The fact of the matter is that it’s different for everyone and it’s actually pretty easy to calculate how much you would need to live off dividends alone. We all have different goals, hobbies and things we would like to accomplish with our time. Most of these things require money and if they don’t require money, they require time which money buys you. Understanding your month to month expenses, the lifestyle you want to live and how to calculate how much you’ll need to achieve these things are crucial to achieving the goal of living off dividends.
Expenses
Before anything else you’re going to need to know exactly how much money you need to spend every month. This number is the absolute minimum you’ll need to retire early. Granted, you wouldn’t have any extra money after paying your bills, you still technically wouldn’t have to work. If your bills add up to $,1500 every month you’re going to need at least $1,500 per month in dividend income. Most dividends are paid quarterly so you’ll need to find your average monthly dividends and budget accordingly. If your expenses vary quite a bit every month then you can budget for yearly expenses.
Being diligent about tracking your expenses on a monthly basis is a must if you want to know how much you need to retire off your dividends. Tracking expenses creates a picture of your financial health that you don’t often see otherwise. Having this information available to you allows you to make changes and see exactly where you can cut back or where you’re overspending. Tracking your net worth is also extremely beneficial to understanding your current situation and for tracking progress. I usePersonal Capital to track my net worth. It’s phenomenal, honestly. I login almost daily to keep an eye on things. If you want to check it out, use my link to sign-up
