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The Simple Dollar

How do dividend-bearing stocks work?

By putting money into companies you believe in, you can support a valued business and make back some profit in dividends

By Guest blogger / April 14, 2011

Cans of Coca-Cola and Diet Coke are shown in a cooler in Anne's Deli Thursday, March 17, 2011, in Portland, Ore. If you bought $20,000 worth of Coca-Cola stock right now, you could reasonably expect a payment of $133.65 each quarter, writes guest blogger Trent Hamm.

AP / File

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As I’ve mentioned several times recently on The Simple Dollar, one of my biggest areas of thinking in terms of personal finance right now is how to create a secure future for myself and my family. Right now, except for our mortgage (which has a pretty low interest rate), we’re debt free. We own both of our cars and they won’t need replacing soon. Our bills are relatively low. We have a very healthy cash emergency fund. After all that, we still spend substantially less than we earn.

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Our question then becomes what can we do with that difference to secure our financial life in the future?

We have several avenues, of course. For one, we could simply accumulate cash in savings accounts and CDs. For another, we could buy highly secure investments that would return a bit more than savings accounts. We could also seek to simply maximize returns by investing in stocks that would give us a large return over the long haul.

However, after a lot of discussion, our biggest interest is in turning that money into a passive income stream while also using that money to support companies we believe in. We’d take our money and put it into a handful of companies we believe in – or at least ones that aren’t involved in businesses we find unethical or problematic – and then use the dividends paid by those stocks as an income stream. Our goal would be to avoid selling those stocks for a very long time, if ever, as the purpose would be to have a steady stream of income via the dividends.

Personal finance 101 here: dividends are small payments given to the holder of each and every share of a company on a regular basis. Many companies do this as a method of encouraging investment in that company and returning value to the people who own the company (the shareholders).

So, how would this work?

Let’s take a look at, say, Coca-Cola (stock symbol: KO). Coca-Cola’s stock pays approximately a 3% yield each year, which means that if the stock is valued at 100 steadily over the course of a year, you would receive $3 over the course of that year in dividend payments. So, if I bought one share of Coca-Cola today (at 67.40) and it held that value, I could reasonably expect to receive $2 over the coming year.

Let’s say, right now, we bought $20,000 in Coca-Cola stock. That would net us about 297 shares of KO, which we would then sit on for the time being. Each quarter, we’d earn a dividend payment of around $0.45 per share or so, based on the historical data, and that amount will likely inch upward over time. That’s a payment, each quarter, of $133.65.

$133.65 every three months? That’s not much, it seems. However, there are a few important things to remember. First, those payments will go out as long as the Coca-Cola Corporation exists and continues to pay dividends. Second, if I want my initial investment back, I can get some significant component of it back by simply selling the stock. If the stock is up, I could make some money just from selling the stock. If it’s down, I still made money from the dividend payments.

There’s also the question about future savings. If I were to continue to invest future savings in other dividend-paying stocks, I could eventually reach a point where the dividend payments are producing a significant portion of my personal income. This is exactly how many older and retired businessmen live – they earn income from the dividends on their stocks, and if you have enough, you can easily live off of them.