You think you’re are ready to jump into the stock market to earn tons of money. It all sounds amazing until you find yourself making a few mistakes. Don’t worry. We’ve all make them. Not every stock we buy will turn out to be a winner. With more knowledge, you can avoid making some of the common mistakes.
6 dividend investing mistakes that are easy to make when you first start
Paying high trade commissions
When I first started investing online investing wasn’t commonly available. The brokerage companies preferred you phone in the trade rather than meet with one of their brokers in person. I chose to place my trades in in-person, resulting in a much higher commission. I thought I would make the money back quickly through stock price increases and dividend reinvestment.
Fortunately today most of the discount online brokers offer a reasonably priced trade. You should be able to open an account offering trades anywhere from $5 to $7. Making back your money to break even is much easier than the $30+ fee I paid “back in the day”.
Depending on your investment strategy and goals, you can also check out the free trading platforms. Last I checked, they don’t offer dividend reinvestment services so they don’t fit my strategy.
Moral of the story: Double-check the fee schedules and choose your brokerage company wisely. Be an informed investor.
Not buying enough shares to create a new reinvestment share in a reasonable amount of time
The concept is relatively straight forward. The company pays a dividend to the stockholder for each share she owns. The brokerage company takes the money and converts it into new shares. It may result in whole shares or fractional (partial) shares.
When you first start investing in dividend stocks, make sure you do the math upfront to estimate the dividends you’ll receive per quarter along with how many shares that will likely turn into.
For example: Let’s see what happens if you have 4 shares of stock in your portfolio that pay $0.20 per share per quarter. You’ll receive a $.80 quarterly payment. Now let’s assume the stock price is $40 at the time. Your holding for the stock will now be 4.02. Yes, you received a tiny partial share. Per year that could result in less than a tenth of a share and maybe have a full share in 10 years, give or take!
In my case, I didn’t check how much I would receive in dividends per quarter on 3 to 5 shares of stock. And then how much that dividend would buy in terms of new shares. It ultimately turned out to be the tiniest of fractional shares that would have taken a decade or more to create one share.
Moral of the story: Do some quick math upfront to estimate your per quarter dividend and dividend reinvestment shares. While this shouldn’t stop you from investing in a stock, you may want to think twice about setting up reinvestment depending on how long you think you’ll hold the stock.
Moving stock between brokerage companies only moves full shares
This may be less of a concern for you, but if you decide to move your stock between brokerage companies, they only send the full shares. The partial shares are sold, creating more paperwork for your next tax filing.
Depending on how well your stock was reinvesting, you may find that stock back where you started. All of the tiny factional shares are wiped out.
Sometimes you need to move your stock between brokerage companies because they change their account minimums. Or maybe your day job has requirements on where you can hold stock. Or you simply want to use a different brokerage company.
For whatever the reason, just be aware you’ll likely see the partial shares sold as part of the process. If you think you’ll need to move between brokerage companies, it’s even more important to do the upfront math to estimate your reinvestment shares. Reinvesting is worth in the long term, but if you’re not getting to a full share before the transfer, the paperwork is not worth the headache.
Moral of the story: Know that your partial shares don’t transfer when you move your stock between brokerage companies and that you’ll have paperwork at the next tax year. When you’re making a stock purchase, double-check the math to make sure you’ll get to a full share at some point before transferring accounts.
Not setting the stock to reinvest dividends
Depending on how your account is set up, it might not automatically reinvest dividends. If your strategy is tied to reinvestment, you may be missing out if your account is set to keep the dividends in cash.
This has happened to me multiple times and continues to happen as I build my dividend portfolio for monthly income. Every time I think my account is set up properly I miss reinvestment a dividend payment because the new stock I purchases was not set correctly.
Moral of the story: Double-check your account settings when you start and double-check the settings after each new stock purchase. If you buy a stock close the dividend x-date you may risk not having the dividend invested for the first payment.
Not realizing you have to pay taxes on dividends each year (if it’s in a non-IRA account)
Check with your favorite tax professional for more information on what applies to you. For stock held in regular brokerage accounts (not your retirement accounts), you’ll likely need to pay taxes on the dividends received.
I admit when I first started I thought reinvesting dividends put off owing taxes until I sold the shares. I wasn’t earning too much in dividends at the time to really notice beyond the additional tax paperwork.
Your actual tax rate on the dividends will depend on the type of stock and how long you’ve held it. Take a look at your 1040 and 1099s. You will see boxes for qualified and ordinary dividends. The qualified dividends are taxed at a lower rate than ordinary dividends. Ordinary dividends are taxed at your regular income tax rate.
Check with the IRS or your favorite tax professional for more information on this.
Moral of the story: Having to pay taxes on your earnings shouldn’t stop you from buying stock in a non-IRA account. You’re probably not going to stop working because you have to pay taxes right? When you buy stocks in a retirement account, remember to keep in mind the tax rates of the types of stocks you buy. Ask your if this is the most efficient way to use your money or is there a better option?
Chasing dividend yield for quicker earnings
Dividend yield is the current stock price divided by the stock’s annual dividend. It’s a percentage to help you understand the ROI (Return on Investment) for your money. It feels like you’ll earn more money faster if you find stocks with higher dividend yields.
Beware.
For regular stocks, an abnormally high yield could be an indicator of a problem with the company. And it could also result in a dividend cut, which usually results in a drop in the stock price.
While trying to “get rich quick” you not only risk a drop in the dividend you were chasing you may also see a drop in the value of the stock.
The few times I purchased a few stocks on the higher end dividend yields, I was burned. The dividend was cut and my investment dropped in value.
What is a “safe” dividend yield?
It will be a personal decision for you based on your strategy and risk tolerance. With “regular” stocks and companies, anything from 2.5% to less than 4% is in the normal range. If the dividend yield is higher than that, make sure you take a closer look at what’s going on with the company before buying shares.
Moral of the story: Depending on your risk tolerance, buying “regular” stocks with yields considered to be abnormally high could be a sign a rate cut is expected, resulting in lost value. Sometimes you can make a few extra dollars chasing dividend yields. Sometimes you lose more than you hoped.
Wrapping up. What other dividend investing mistakes have you seen?
Buying stock, even a small number of shares can be a good learning experience. Sometimes you’ll do really well, and sometimes things won’t go as expected. The learning from those experiences will help you make better decisions in the future.
Don’t look at any of your dividend investing mistakes as failures. Look at them as opportunities to do better in the future. And let’s face it since we can’t predict the market there will be times where losses aren’t really mistakes. We do the best we can with the information we have at the time.
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