Investing To Generate A Steady Monthly Income Stream
One way to teach someone about investing is to help show them a tangible consequence of putting their money to work. Businesses rarely will have money sitting idle because they know that they can make it earn them a return. Money makes money, have no doubt about that! There are numerous options to choose from when it comes to getting a return on your invested dollars. Let’s talk about a mainstream one.
Our households would be better off if run, more often, as a business. If we need to generate $7.99/month of income in order to cover an expense, let’s say a Netflix subscription, then we need to sell enough product or service in order to make that happen.
In this post, I would like to outline how we can utilize investing to generate the income needed to cover a Netflix subscription, indefinitely. Why? Because I’m running out of ideas for posts, so just read on.
Working With Dividends
As a matter of fact, let’s imagine that we’re teaching our 12-year-old about money and investing. I think dividends are the easiest way to start.
A publicly traded stock uses the money from investors in order to invest in more income generating assets. A fast-food chain uses it to secure more locations and an auto manufacturer buys more raw material or real estate for factories.
The most logical fund to use for this example would be a real estate fund, also referred to as REIT, real estate investment trust. It’s a publicly traded stock that’s a business which buys real estate and, in this example, rents it out. The more money they have access to, the more properties they can buy.
In order to encourage investors to invest their money with them, they offer a high dividend yield. This is money that the company pays out 4x per year to the investor.
A dividend yield is a certain percentage of the value of each stock unit that’s paid back to the investor. As long as they are doing well, the company should continue to grow, either in the value of the stock or by increasing their dividends.
Let’s use Realty Income Corporation. Stock symbol “O”. I am only using this one because it has had a long enough track record and will help make my point. I am not suggesting it as an investment.
Realty Income Corp
This stock is floating somewhere at $60 per share. For each share, you get 4.23% of dividends per year, paid out 4x per year.
If the value of the stock goes down so will the dividend payout (not the percentage).
The company may decide to raise or lower the dividend percentage based on how the company is doing and how much more investment money they are trying to attract.
Taxes On Dividends
We will first calculate everything gross and then factor in taxes. Dividends on REIT’s are usually taxed at normal income tax rates. If you are in the 25% tax bracket then you would pay 25% of the dividend profits to the IRS.
Some dividends will be taxed at lower rates but that’s a different discussion for a different post.
Appreciation Of The Stock Value
Remember how I said we would indefinitely create an income stream to fund our Netflix addiction?
The stock will likely appreciate over time. This isn’t guaranteed but if you have chosen a good company then it should have some up and down fluctuations and eventual appreciation.
I’m really simplifying things here and I realize that my readers are smart enough to understand that there is no way to predict future performance of any publicly traded security.
The basic concept, however, holds true that whether due to inflation or performance, the value of good stocks increases over time.
Replacing The Cost Of The Membership
We need $7.99 a month on an ongoing basis in order to cover the expense of the Netflix membership and not have to pay a single penny out of pocket.
$8/months is $96/year of income needed from any investment.
Since we need to account for taxes, say 30%, we’ll aim to generate $137/year or $11.40/month.
The dividend yield is 4.23%, so we need $3,239 invested in order to kick out a $137 dividend income, year after year.
Therefore, by investing $3,239 in a dividend producing investment, we would never have to pay for Netflix again. It’s not that the membership is now free, but we no longer need to worry about it.
In a way, we do this when we sign a contract for a full-time job. We get our health insurance paid for by this job commitment. It’s not that it’s now free, but we no longer need to worry about it.
Stock Price Fluctuations
Naturally, since this is a stock, it will go up at times and down at times.
Though many “experts” like to speculate why this happens, the fact remains that nobody knows exactly why markets fluctuate the way they do.
On the wards, one septic 70-year-old will respond beautifully to IV antibiotics and another 70-year-old of same health will need multiple pressors and additional IV antibiotics in order to get through it.
Different doctors will speculate on the difference in response, but no single doctor has the exact facts.
Back to our stock, in the past 5 years, this stock has had a high of $70 and a low of $40 per stock. Let’s talk about how our dividend income would be affected by such price fluctuations and what we can mitigate the ups and downs.
Stock Prices Going Down
When the value of the stock goes down, let’s say from $60 to $50, so does the payout. After all, the yield is tied to the price of the individual stock unit.
If you are getting a yield of 4.23% and your investment of $3,239 goes down to $2,699, you will only get $114 of dividends a year, or $9.50/month. After tax, you’d have less than the $8 you need per month.
So, you could either buy a little more than the $3,239 or you could enjoy the current market price and slowly add a little to this investment over time in order to create the wiggle room you need, should the stock price drop down in the future.
Below, we’re gonna talk about another method of selling appreciated stock to buffer for such fluctuations.
Fluctuating Dividend Yield Rates
There is one other phenomenon to consider when investing in stocks. The company may decide to drop their dividend yield for various reasons.
If the stock price goes up a lot, they might decide to drop the yield percentage down a bit in order to stay competitive and have more money to continue investing in such a bull market.
If the stock price drops down then they might actually increase their dividend yield percentage in order to encourage investors to put more money into their stock.
Stock Prices Going Up
You can sell some of the appreciated stock, pay taxes on the gains and then use the money to buy more stocks.
This is a strategy to increase your holding in the particular company so that you are putting the extra money to good use.
Also, if you are suddenly earning $12/month after taxes, instead of the $8/month which you were aiming for, then you could take the extra $4 and put it in a savings account.
This savings account will be the buffer account so that you can ride out future stock price fluctuations.
Should the stock price go down in the future then you cover the extra expense from the money you stashed in this savings account until the time comes when the fund value eventually goes back up.
Extrapolating This Concept
There are certain concepts that, once understood and executed successfully, can be applied to damn near everything. Such is the nature of viable concepts as opposed to fads.
I consider the whole game of travel hacking and trying to score free travel rewards a fad. It works but requires a lot of spending, whether real or manufactured. It can take up a lot of your time and taxes your attention to make sure you play the credit card game just right.
The dividend model has been around for a long time and is viable. Now that you have taught your young teenager or your partner how to invest money that will cover a certain expense, you can use this concept to cover other expenses.
You can cover your cell phone bill.
You can pay for the lease of a car.
You can cover your health insurance premiums.
If you are invested in publicly traded securities, take the time and look through your investments to determine what the dividend yield is for each investment and calculate your current passive income.