Saturday, November 30, 2013

Why invest money? Part 2

This is post in a continuation a recent article called Why Invest Money ? Part 1.

The traditional way to save  money was to put your money in  a bank account. This bank account will then pay you interest on the balance of the account calculated over usually over a calendar month. This interest rate is very small as interest rates are at historic lows right now. Also, the interest received is taxed at marginal rate. Therefore, when saving money in a bank account right now, an individual is actually losing money because of inflation.  Having a bit of savings is important though, such as for an emergency fund.  Savings can be used to help pay for a down payment on a house or wedding for example.
   I invest money in companies that pay me to own them. I am mostly invested in corporations and REITs at the money.  These companies pay me once a month or once a quarter. This money in the form of dividends or distributions is more tax efficient than interest from a bank. When a company makes more money they often reward their shareholders with increased payouts. The increase in payouts is, in most cases, greater than the rate of inflation.

        Yield on Cost  (YoC) = annual dividend rate / purchase price
         Current Yield = annual dividend rate / current price

 Example : If stock ABC pays a annual dividend of $1.00 per share and I paid $20.00 per share, then
                  yield on cost is 5%.   In 5 months time, the price of the stock goes to $25.00, then the                   current yield is 4%. If company ABC raises the dividend by $0.05 to $1.05 per share,                    YOC increases to 5.25% meaning your initial investment is working harder for you.

The interest rate on a savings account will not have increases that are greater than the rate of inflation.

With the dividends and distributions being more tax efficient, that means I get to keep more of my money. As the amounts of dividends and distributions I receive on an annual basis increases, I am able to have more options. This money can be used to enjoy a better lifestyle, to save for retirement of financial independence at a quicker rate, or to leave a job if it is not a good fit for me.

 If a person is living paycheck to paycheck, they have to keep working there to they are able to find a different job. The job they hate currently have a negative effect on their mood which can have negative effects in a interview setting.

Increasing passive income allows a person to have more options. They are able to sleep better as they are less stress. Financial independence is when there is enough passive income to exceed expenses. When this occurs, an individual can CHOOSE to do what they want with their time.


     I am not a financial planner, financial advisor, accountant or tax attorney. The information on this blog represents my own thoughts and opinions and should NOT be taken as investment or business advice.  Every individual should do their due diligence to make their own financial decisions based on their financial situation and tolerance for risk


  1. One question:

    Do you calculate with dividends do you received?
    For eyample: You buy a share for 20 USD. The dividend in the first quarter is 0.50 USD, in the second quarter 0.50 USD again and so on...
    After the first quarter, you have a YOC about 2.5%, correct?
    And after the second quarter, you have received 1 USD dividend = YOC 5% - correct?

    Or do you simply take the value of the dividends from the last 12 months, regardless of whether and when did you get the money or not?


    1. Dividenden-Sammler,

      I use the annual dividend rate. This is what is quoted on yahoo finance or google finance in their summary part and not the actual chart. I also can go to the company's investor relations page and find the dividend information there.

      Whenever a company raises their dividend or I purchase more shares, is when the YOC will be updated. Whether the dividend gets paid monthly, quarterly, semi-annually or annually has no effect on my YOC.

  2. Hi IP,
    It's incredible the YOC you get once a company has increased it's dividends over time. The investments that throw off the most cash in our portfolio were all yielding 3 or 4% when we bought them. Now, after just a few years, they are paying 6 to 10% on our original cash. There will be bumps along the way, but imagine how much passive income they will produce 20 or 30 years from now. All we're loosing is opportunity cost in the mean time.