Companies that pay dividends monthly are usually targeting income-seeking investors who prefer the convenience of payouts that align with household bills.
getty
About 100 U.S. stocks pay dividends monthly—and at least two dozen of them currently have generous, double-digit yields. Can these high-yield monthly dividend payers could help expedite your wealth plan? Yes, but only if you manage the risks.
About Monthly Dividend Stocks
Companies that pay dividends monthly generally fall into two types. The first is a business model with predictable income cycles that naturally supports monthly payouts, such as:
- Real estate investment trusts. REITs own, manage, and lease or finance real estate. Revenues are primarily contracted rents, interest payments, or loan payments, which are predictable unless customers default. REITs are required to distribute 90% of their taxable income to shareholders.
- Business development companies. BDCs provide financing for small and mid-sized private companies. BDCs, like REITs, must pay 90% of their income out to shareholders.
The second type is the security that targets investors who want high-yield, monthly income. Closed end funds or CEFs fall into this category. These are actively managed, exchange-traded funds that can hold stocks, bonds, and other assets. The underlying assets may not produce predictable monthly revenue, but the fund offers monthly distributions anyway.
CEFs can use debt and option strategies to increase yield, and distributions sometimes include the return of capital. Return of capital makes the yield look higher, without producing true income.
Advantages
For investors, monthly dividend payments have convenience and compounding advantages.
Convenience. Monthly income is easier to budget. It follows the timing of rent, utilities, and other normal household bills.
Compounding. The compounding advantage is a factor when you’re reinvesting the dividend income. There is a quantifiable financial benefit to reinvesting your income 12 times a year versus four. For example, if you are earning a 10% yield on a $100,000 position, a monthly dividend reinvested produces about $90 more in year one than a quarterly dividend.
- Monthly: $100,000 x (1+0.1/12)^12=$110,471.31
- Quarterly: $100,000 x (1+0.1/4)^4=$110,381.2
The gap widens over time, too. By the 10th year, the cumulative advantage of the monthly dividend is nearly $2,200.
Disadvantages
Monthly dividend payers also have disadvantages, and some can be deal-breakers depending on your situation.
- Tax complexity. If you are investing in a taxable account, monthly dividend payments give you more transactions to track. And some of those dividends may be taxable at higher rates. For example, income from REITs and BDCs is 0ften nonqualified, meaning it’s taxed as ordinary income. Qualified dividends—from U.S. companies that pay corporate taxes—are taxed at the lower long-term capital gains rates.
- Misleading yields. Some monthly dividend stocks have high distribution yields and negative total returns. Total return represents what you make on a security, including the income and changes in market value. You aren’t making money on a 20% yield if the total return is negative.
- Limited diversification opportunities. It’s hard to build a diversified portfolio with only monthly payers. You won’t have access to the top companies in the S&P 500, for example, which many investors view as core positions.
- Other risks. Some income strategies used by monthly dividend stocks can introduce additional risks. For example, BDCs may loan money to borrowers with a higher-than-average default risk. And CEFs may use leverage to amplify returns. Leverage also amplifies losses.
Questions To Ask About High-Yield Monthly Payers
Before investing in a high-yield monthly dividend stock, ask:
- What’s the total return? Generally, you want the total return to be at least equal to the dividend yield over the medium and long term. If it is less, the stock lost value.
- Why is the yield so high? Yields can be high for right and wrong reasons. Right reasons include strong cash flow, or measured use of leverage or options strategies. Questionable reasons include return of capital and a falling share price.
- How consistent has the dividend been? A long history of dividend payments shows cash flow discipline. Recent dividend cuts and pauses could indicate uneven or unpredictable business results.
- Is the yield sustainable? The core business of the company or fund should be generating enough cash to pay the dividend. Dividends cannot be supported indefinitely by borrowing or return of capital.
- For CEFs, what is the expense ratio? CEFs charge expense ratios, which may include interest expense if the fund uses leverage. Fund expenses dilute your returns.
Managing The Risk
The advantages of high-yield monthly dividend stocks can be compelling enough that you accept the disadvantages. But you don’t have to accept them blindly. Strategies you can take to manage the added risk include:
- Allocation caps. Keep your exposure to riskier positions capped to a small percentage of your portfolio.
- Diversification. Invest in safer dividend stocks alongside your more aggressive income producers. Blue-chip companies and Dividend Aristocrats are usually reliable options.
- Defined exit strategy. Decide upfront what factors would prompt you to sell the stock. These might include a dividend decline or pause, a price decline of 10% or more, a deterioration of business fundamentals, or rising leverage.
- Performance reviews. Check in on your riskier stocks more often. Monitor dividend yield, total return, leverage, and the pricing trend.
The Passive Paycheck
Dividends are generally considered passive income, but they can demand more hands-on attention when they come from riskier stocks. Most high-yield monthly dividend payers fall into that riskier category. If you manage them carefully, they can be lucrative. But if you prefer your portfolio to be lower-maintenance, a high-yield dividend fund may be a better choice.
