Introducing Our Guest Essayist
The Dividend Capture Strategy
Two Strategies to Reduce Risk
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Note from Cabot Wealth Advisory Editor Elyse Andrews: Occasionally, we bring you articles from guest editors that we think you will enjoy and benefit from. Today, you're going to hear from Carla Pasternak, editor of High-Yield Investing at StreetAuthority, as she discusses a strategy that can boost your dividend income. I hope you enjoy it!
Are you looking for a quick way to boost your tax-advantaged income? This strategy is as simple as it gets for locking in more income from the same investment dollars.
In each issue of High-Yield Investing, I include a "Dividend Capture Dates" section.
The dividend capture strategy is simple: You buy a dividend-paying stock right before it's about to go ex-dividend and hold it for at least 61 days so the income qualifies for the lowest possible dividend tax rate. Then, you sell it and use the money to buy another stock that's about to go ex-dividend.
With the right timing, investors can grab huge special payouts when a company puts in a strong performance or is restructuring. Last month, I told High-Yield Investing readers about the $1.40 per share payment from American Capital (Nasdaq: AGNC), which totaled about 5% of its share price. I also flagged the $1.35 payment from National Beverage (Nasdaq: FIZZ). That amount totaled 10.3% of the share price.
There's one problem, though. Once the stock goes ex-dividend, the share price typically drops by the amount of the dividend. This makes sense--the day a dividend payment passes, the stock is worth less to new investors.
In a bull market, by the time you hold 61 days the shares are likely to recoup the losses. But in a flat or bear market, some stocks fall even more after offering large payouts, and there are no guarantees they will recover. When that happens, you could end up losing more from the lower share price than you made in the dividend.
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While there is no surefire way to mitigate the entire risk of the dividend capture strategy, investors can make up for some of the downward pressure of the approach by rotating in and out of stocks.
Here's what to do: Pair two stocks that pay quarterly dividends at different intervals and hold onto each for the minimum required 61 days to get the reduced dividend tax rate. By doing so, you'll squeeze out two extra payments a year with the same investment capital. This extra income could make up for any stocks that don't rebound after their dividend payment.
Let's say "Stock A" and "Stock B" each sell for $100 per share and pay a 12% dividend yield (meaning each delivers a total annual payment of $12 a share). That equates to a dividend payment of $3 a share each quarter.
By rotating in and out of the two stocks, you can capture six tax-advantaged quarterly dividends each year, for a total of $18 with the same investment dollars instead of $12. In other words, you can boost your annual yield from 12% to 18% by rotating in and out of these two stocks.
Here's a more specific example of how it might work. Say you buy "Stock A" before it goes ex-dividend at the end of December and sell it at the end of February. You pocket $3 a share from "Stock A." You then use the money you get from selling "Stock A" to buy "Stock B" before it goes ex-dividend at the beginning of March and sell it at the end of April. You pocket $3 per share from "Stock B."
You rotate in and out of these two stocks six times, buying one just before it goes ex-dividend, holding it for the minimum required 61 days, selling it after you've pocketed the dividend, and using the funds to buy back the other one.
Remember: While this strategy can boost already impressive yields, it's not risk-free. There's no guarantee that the extra income will cover any falls in the share price.
That said, using a dividend capture strategy is one of the most simple ways you can boost your income stream throughout the year. It's no wonder "Dividend Capture Dates" is one of the most popular sections in High-Yield Investing!
Editor of StreetAuthroity's High-Yield Investing
P.S. In just two short weeks, I'll be publishing my March issue of High-Yield Investing, which will have my latest dividend capture opportunities. To make sure you don't miss any of the chances to capture as much as 10% yields in single payments, I invite you to try a no-risk subscription.