Grow Your Retirement Portfolio with Dividends

In the past, I typically looked at four criteria to evaluate mutual funds for my retirement portfolio:

  • Asset Allocation – The asset classes (i.e., stocks, bonds, cash, etc.) I have chosen to invest in based on my timeline and risk tolerance.  Since retirement is in the distant future, I’m willing to incur more risk in seeking higher returns.  For me this means a portfolio that is heavy with stock funds.
  • Rate of Return – The higher this number is, the better.  I look at rates of return over large periods of time (five, ten, twenty year windows) since I have a long time until I retire.  Also, I compare rates of return with mutual funds in the same class (small-cap, mid-cap, international, etc.), with the goal of choosing a relatively better performing fund if I have the ability to choose from multiple funds within the same class.
  • Expense Ratio – The lower this number is, the better.  Expense ratios, measured as a percentage of your investment, track what it costs an investment organization to run a mutual fund.  If I am able to select from multiple funds within the same class and the funds have relatively similar rates of return, I choose the fund with the lowest expense ratio.  The lower the expense ratio, the more money you get to line your own, rather than somebody else’s, pockets.
  • Morningstar Rating – This rating measures how a mutual fund has performed relative to other funds in the same class.  Mutual funds are rated on a scale of five stars- this helps you to gauge whether a fund you’re selecting is a bad performer.  If a fund has one star, it’s in the bottom 10% of its class- stay away.  The next four stars chart the next best 22.5%, 35%, 22.5%, and 10% of performers.

This January, after evaluating the performance of my mutual funds, I discovered another criteria with which to evaluate mutual funds and stumbled across something that caused my balance to grow more than I expected:  dividends.  Dividends are company earnings that a given company can choose to distribute to its shareholders.  Not all companies distribute dividends, as a dividend distribution requires that companies have surplus cash.  Dividends are generally distributed once, twice, or four times a year and a company may choose to increase or decrease dividend payments, or may choose to start or stop issuing dividends according to the wishes of its leadership.  Note that dividend payments are included in a mutual fund’s rate of return, so use dividend yields as only one criteria when choosing to invest.

From December 2011 to January 2012, I noticed one of my mutual fund balances had increased by several hundred dollars, equivalent to slightly more than 3% of my previous balance.  My initial thought was:  “Wow, I wasn’t expecting this!”  I then became curious how to calculate this amount and how I might calculate future dividend payments.  Using finance.yahoo.com, I plugged in the ticker symbol associated with the mutual fund (FFFFX in this case).  I then went to the “Historical Prices” page and selected “Dividends Only” and clicked “Get Prices”. For the dividend issued on December 29, 2011, you see “0.25 Dividend”, which means I was given a dividend of 25 cents per share. To use a round number, let’s assume I started December 29 with 1,000 shares at an opening value of $7.36 per share, which translates to $7,360 total in FFFFX.  The 25 cent dividend was then multiplied by my 1,000 shares, for earnings of $250.  Rather than only experiencing an increase in share price, I acquired 33.97 additional shares, which will allow future dividend payments to grow, as future dividend payments will be calculated based on the 1,033.97  shares I hold rather than the original 1,000 shares.

A key takeaway:  Reinvest dividend payments.  This will allow for future dividend payments to multiply on top of previous dividend payments.  For long-term buy and hold investors, in addition to regular contributions, time, and compounding interest, dividends are an additional tool you can use to grow your retirement portfolio.

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