How to Build a Dividend Ladder

“I believe non-dividend stocks aren’t much more than baseball cards. They are [only] worth what you can convince someone to pay for it.”

Mark Cuban

A dividend ladder is the rich man’s way of making their own paycheck. It’s an awesome tool to generate income, merely by holding stocks in various companies. You’re paid a set amount at a certain time, on a schedule, and you don’t even have to get out of bed in the morning to earn it. But before we can discuss what a dividend ladder is, you have to know what a dividend is.

Simply put, a dividend is profit paid out by a company to its shareholders. Think of it as a reward for holding on to a company’s stock. It only makes sense, for as a shareholder, you OWN part of that company. If it does well, you get to share in the proceeds. Not all companies pay dividends, however. It’s usually up to the discretion of the company to pay any dividends, and the company can lower the dividend or even outright end it if it sees fit. For example, the company I used to work for T-Mobile (TMUS), stopped paying a dividend in May 2013.

Great, so dividends are cash paid to shareholders by the company. So what is a dividend ladder?

Most dividends are paid on a quarterly schedule. To stick with telecommunications companies, take a look at Verizon (VZ). Verizon pays a dividend in January, April, July, and October. The dividend is currently $2.41, paid quarterly — so in each of the above months you would collect about $0.60 per share. A thousand shares of VZ would pay you $600 every three months, regardless if you do a shred of work or not. BP or British Petroleum, pays in February, May, August, and November about $0.59 per share. A thousand shares of BP nets you $590 every three months, but in different months than Verizon.

Let’s take a third stock, Walmart (WMT). A share of WMT currently pays $0.53 per quarter, but pays in March, June, September, and December. One thousand shares of WMT would pay you $530 three different months. So with your three stocks, you now collect $600 in January, $590 in February, $530 in March, and repeat throughout the rest of the year. You collect a monthly paycheck from your assets, and you didn’t have to lift a finger. That is a dividend ladder.

The strategy comes in the stock picking. It’s not all WHEN the dividends pay, it’s also other factors such as dividend yield, dividend history, the health of the company, and the risk of having a dividend cut or suspended. A company like Coca-Cola (KO) has increased their dividend for 56 years straight. AT&T (T) is known for prioritizing their dividends, paying them even through the 1930s Great Depression. REITs (Real Estate Investment Trusts) are required to pay out 90% of their profits to shareholders as dividends (tax rules are a little different, again check with your CPA) so they make reliable sources of dividends. MLPs (Master Limited Partnerships) are another example. You also want to diversify your holdings, not buying only consumer companies or only tech companies. There’s protection in splitting up the sectors your holdings are in.

If you’re not one for stock picking or don’t want to do the research, there are plenty of ETFs to choose from. ETFs or Exchange Traded Funds, are baskets of stocks that are already diversified and made up of many holdings. An ETF like Vanguard Dividend Appreciation Index Fund (VIG) is merely a basket of dividend stocks. It pays just like individual stocks would.

The best part about a dividend ladder is you can start before you quit your job. It will take initial investments to get it going. So what if you don’t have a lot of money to invest yet? Start by buying a few shares. When the dividends are paid, you can use your brokerage’s DRIP (Dividend Reinvestment Program) to reinvest the dividends when they’re paid — this means the money from a stock’s dividends is used to then buy more shares (or fractions of shares if it’s not enough to buy a whole share). Or, you can let the money pool in the account and buy more shares. It works like a snowball, start small and let it grow over time. If you start before you quit your job, you can have a nice portfolio paying you monthly when you do leave.

To get started, I recommend check out http://www.dividend.com’s Dividend Stock Screener to look through the list of all dividend-paying companies. Always do your homework when it comes to stocks! I’ll be publishing more posts on stocks and dividends, so stay tuned!

Full disclosure: I do own shares of T and VIG in various accounts. I am in no way affiliated with Dividend.com, but I do use it on occasion for research.