Stock dividends are a great way to increase earnings in a low interest rate environment. Combined with the covered call writing strategy, we can increase our returns on investment and minimize the downside risks at the same time.
If you don’t need the income from dividends now, you can opt in to take part in a DRIP – Dividend Reinvestment Plan, which is offered by a corporation that allows investors to reinvest their cash dividends by purchasing additional shares or fractional shares. Here’s a list of companies that offers DRIP.
Dividend-paying stocks offer the ability to generate steady income, but also capital appreciation. The great value of a DRIP is that it continually grows the number of shares that you hold and increase your earning power.
If a company that trades on a current yield of 3% and pays out a dividend every six months. An investor holds 1,000 shares which are trading at $50. If he elects to receive the dividends, he’ll receive $750, twice a year, or about $1,500 in total.
If he elects to take part in the DRIP, he’ll receive 15 additional shares. 6 months later, the second dividend will be calculated based on the 1,015 shares, and not the 1,000 shares he originally owns. This is how powerful dividend growth compounding can be. Do this for a decade and the result can be staggering.
A DRIP also helps reduce the headache of market timing and fluctuations. That is, trying to pick the best time to buy them. By receiving new shares every x number of months, the dollar cost averaging comes into play. When the share price is low, we’ll receive more shares, and vice versa.
Covered Call Writing
In Part II, we’ll see how to utilize covered call writing to further manage the investment risks and generate another source of steady income.