Investing For Monthly Income: Dividend Aristocrats And Kings

Photo by Cristina Gottardi

Why I Closed My Self-Directed Roth IRA

Many years ago, I started a self-directed Roth IRA so that I could use my IRA funds to invest in real estate, mainly as a hard money lender. My partner has been having a hard time finding good deals lately, due to the low interest rates. When I started, we could charge borrowers 12%, which is a pretty sweet return. The last couple of years have seen that drop down to 6%. Now that interest rates are rising, we’re back at about 8%, but it’s still not close to what I used to be able to earn.

Besides the lack of deals, the second reason I’m exiting from this is the account fees are pretty steep. The IRA custodian assesses a yearly fee of around $375. I started out with $35,000 years ago and that fee was about one and a half month’s income at 12%. Over time, the account has grown to roughly $70,000 and at 8%, that fee is now less than 1 month’s income. However, deals have been fairly hard to come by over the past year, so there were many months where I wasn’t generating any income.

I also felt like the custodian was, shall we say, not the best. I mean, they are a legit company and everything they did was legal, but they just weren’t very technologically savvy. Their website kinda sucked. It just had the feel of a really small, understaffed company to me, even though they are not. I didn’t feel very comfortable using them now that the account value had doubled.

So I opted to close the account and roll the funds into my Roth IRA at Schwab and invest in the stock market.

(As a side note, I started the self-directed IRA with $35,000 and I ended up with slightly more than double that in 8.73 years. According to this calculator, that works out to an annualized ROI of 8.26%. When I started it, I had hoped to earn around 10% - 12%, as that's what I was getting at the time. Still, this was a Roth IRA, so the returns are tax free and, according to this calculator, that's equivalent to an after-tax return of 11.0%. My returns could have been better, but I was not invested in anything for the last 9 to 12 months I had the account.)

Now that the rollover process has been completed, I’ve got $70,000 ready to invest in the stock market. The big question is how to invest it.

Of Aristocrats and Kings

One of the financial blogs I follow, Wallet Hacks, recently had a post about building a monthly income portfolio. In other words, build a portfolio that recevies dividend income every month. This isn't a new idea and I've heard of many other investors that have done the same thing, but my recent lump sum transfer into my IRA meant I could jump start this strategy with a big chunk of change instead of building it up from zero.

Most companies pay dividends quarterly, although some, mostly REITS, pay monthly. The goal of this type of portfolio then, is to own stocks so that their quarterly dividend payout dates are staggered. Have some that pay out during the first month of the quarter, some the second month of the quarter, and some the third month of the quarter. This way, you have income coming in every month. As a real estate investor at heart, I’m really big on cash flow and this concept appeals to me.

The question becomes which stocks should you buy? Because you will (theoretically) be relying on these dividends for monthly income when you are retired, you want companies that will be around for the long haul and will not reduce or cancel their dividend. Luckily, there is a name for these companies: Dividend Aristocrats.

A Dividend Aristocrat is a company that has had a history of at least 25 years of increasing dividends. Twenty five years is a long time, so these companies tend to be fairly well established and will likely be around for years to come. (Although age is not a guarantee of a profitable company. Just look at Sears.) These are stable companies that have a history not only of continuing to pay, but of also increasing their dividends. This is important over the long term because inflation will eat away at the value of the payments if they do not increase over time.

Dividend Aristocrats is not a term that financial bloggers dreamed up. The list is actually compiled and tracked by Standard & Poors.

But if you want even more security, there is a subset of the Dividend Aristocrats that are even more impressive – the Dividend Kings. These companies have a record of not twenty five, but fifty years of continuous dividend increases! That’s pretty damn impressive. These are stocks you can buy and hold forever and never think about again.

My Choices

I selected three to five companies from the list of Dividend Kings that distribute dividends in the first, second, and third months of each quarter. Below is my list, with my final choices in yellow. The last two entries in the list, the Vanguard and Schwab index funds, I already own and I’ve listed when they pay out dividends as well. I should also note that I already own shares of Coca-Cola, another Dividend King.

First Month

One thing you’ll notice is I didn’t just go for the company with the highest dividend yield. Rather, I choose the companies based on my thoughts about them and my existing portfolio positions. For example, Federal Realty Investment (FRT) Is a real estate investment trust (REIT) has the highest dividend yield in the bunch, as is common for REITS, but I passed on it. Why? My portfolio already contains a large position in Realty Income (O), which is also a real estate trust. As an added bonus, Realty Income already pays dividends each month.

(On a side note, a Roth IRA is a great place to hold shares of REITs. Due to their unique legal structure, REITs are not taxed at the corporate level, which lets them return more money to investors in the form of dividends, but the trade off is their dividends are taxed as regular income to the recipient instead of at the lower qualified dividend tax rate. Regular income is subject to the highest income tax rate, so by holding shares and receiving dividends in a Roth IRA, where the distributions are tax free, you’ve changed the dividend income from being taxed the highest rate to not being taxed at all!)

That leaves a choice between Cincinnati Financial Corp (CINF) and Genuine Parts Co (GPC). GPC is a company that is a distributor of replacement parts of autos and industrial equipment, office products, and electrical materials. They own the NAPA brand of auto parts. Although they have a higher yield than CINF, I ruled them out because I can see there may be pressure on the auto parts industry years from now. Electric cars have very few parts to wear out and the ones that do will likely not be serviceable by consumers. Granted, gas vehicles will continue to dominate the roads for years and years and GPC is involved in other industries than just automotive, but I just feel like this is a shrinking industry.

The only choice left is Cincinnati Finanical Corp. They are a property and casualty insurance company. Insurance is something that people will always need and, being a shareholder of Berkshire Hathaway, I’m very familiar with insurance float and how insurance companies use this “borrowed” money to invest and generate income. Now there will be times when natural disasters strike and that will cause short term hits on income and / or company reserves, but that’s the nature of the business. In short, I like their industry and the company in particular.

Second Month

Three choices here: Colgate-Palmolive (CL), Hormel Foods (HRL), and Lowes (LOW).

I rejected Colgate-Palmolive because of millennials. (Why not blame something else on them?) Consumer trends change and brands that have been around forever, such as Colgate and Irish Spring, are seeing sales declines as consumers' tastes shift away from huge corporate brands and focus on locally crafted, boutique brands. I don’t think Colgate-Palmolive, or Proctor & Gamble, or any other of these huge old-school conglomerates will be going out of business anytime soon. Rather, they will adapt to changing tastes, either by spinning off their own boutique brands or buying up existing ones. However, it takes a while for companies this large to react, and that may result in losses that could put pressure on dividend payouts.

Hormel is out because they are, for the most part, a meat company. Like Colgate-Palmolive, they are subject to changing consumer tastes and buying patterns. Does anyone (outside of Hawaii that is) still buy Spam? I guess they must, since it's still being made, but I don't know anyone who buys it.

The harmful effects of large scale meat farming on the environment are negative and undeniable. Granted, many articles on this topic seem to be quite alarmist, but the negative consequences to the planet are numerous. Changes will be coming and it remains to be seen how that will affect meat producers.

That leaves Lowes. As a homeowner, I’m quite familiar with their stores. Their industry seems, to me at least, fairly recession-proof. When the economy is booming and people buy new houses, they will head to Lowes to purchase home improvement items. When the economy is tanking, people will stay in their homes longer, which means trips to Lowes to purchase repair parts. People will always need a place to live and stores like Lowes and Home Depot seem to have a fairly stable and dependable business model.

Third Month

Dover Corp (DOV), Emerson Electric (EMR), Johnson & Johnson (JNJ), 3M (MMM), and Stanley Black & Decker (SWK). I’m going to go against my previous reasoning here and invest in Johnson & Johnson, a large, old conglomerate. I’m not too concerned about millennials or changing consumer patterns here because J & J doesn’t just sell consumer products. They also sell pharmaceuticals and medical devices.

The other companies either don’t excite me or I know little about their industries (Dover Corp. - manufacturer of industrial products, Emerson Electric - engineering services, and 3M – all kinds of stuff) or they overlap industries with other stocks I own. (For example, Stanley Black & Decker overlaps somewhat with Lowes). So for diversification reasons, I’m investing in Johnson and Johnson as a medical / health care industry stock.

If I allocate one-third of my $70,000 to each of the above stocks, I’ll have an average monthly income of about $146. Not a bad start. And I figure I’ve got a least 10 years to reinvest dividends before retiring, so that should compound nicely. That $146 is also on top of the $136 I'm already getting each month from my shares of Realty Income.

What do you think? Have you made any similar investing plans?


Note: This article is not advice to buy or sell any stock. Perform your own due diligence.