Tucking away high dividend-paying oil stocks in a tax shelter like a Roth IRA is one of the most underrated ways that an investor can accelerate the journey of turning an income stream into an income gusher. Companies like BP, Conoco, and Royal Dutch Shell that give investors a 4-5% starting dividend yield that typically grow over time can be a surprisingly effective way to build up your nest egg.
Let’s take a quick look at what can happen if you use a company like Royal Dutch Shell to augment your nest egg. Right now, Royal Dutch Shell trades at $70 per share and pays out a $0.90 quarterly dividend. On an annualized basis, that means you will receive $3.60. I went to Subway yesterday and I ordered Chicken, Bacon, and Ranch footlong that cost a little over $7. Well, if I owned a mere two shares of Royal Dutch Shell (just $140 worth!), I would be receiving $7.20 in oil money income each year. That teensy tiny ownership stake would allow me to have a “free sandwich” each year.
Let’s look at the kinds of things you could do with a company like Shell if you made it a part of your retirement investing strategy. As of current tax law, you are currently allowed to put $5,500 per year into a Roth IRA (as long as you have at least that much in earned income). At Shell’s current price of $70 per share, that means that you could buy 78 shares of the oil giant to put into a tax-sheltered account that would be free from the reach of Uncle Sam. Right off the bat, you would be receiving $280 in annual oil income. Averaging it out daily, you’d be getting $0.77 just for waking up in the morning.
Now just imagine if you put together a five-year plan that went something like this:
In December 2013, I am going to put aside $5,500 to buy 78 shares of Royal Dutch Shell that I will keep inside of a Roth IRA.
In January 2014, I am going to put aside $5,500 to buy 78 shares of Royal Dutch Shell that I will keep inside of a Roth IRA.
For the next four years, I will automatically reinvest the dividends back into Shell, allowing me to benefit from investing’s “Holy Trinity” when you take cash payments, reinvest them back into the company, and then benefit sometime down the road from dividend growth. At that point, I am going to take the Shell dividends and use them to make brand new investments on other companies. Basically, I’ll be treating Shell like my own little dividend machine that, as long as Shell continues to pump out oil from the ground, should be able to pump money into my tax-deferred retirement account every ninety days.
Here are some quick and dirty back-of-the-envelope calculations of what that might look like:
For putting aside $5,500 into a Roth IRA this December (and another $5,500 in January to act as your 2014 contribution), you would buy $11,000 worth of Shell stock that would give you about 156 shares if you could initiate your position at today’s prices.
As of January 2014, your 156 shares of Shell (say that ten times fast!) would be paying out $561 in annual income.
Assuming you reinvest back into the company at $72 per share, you’d pick up an extra 7.79 shares of Shell.
If the company raised its dividend 6% in 2015 to $3.81 and you reinvested at $75, you’d pick up another 8.32 shares.
If Shell gave you another 6% hike in 2016 (to $4.03 per share) and you reinvested at $79, you’d add 8.77 more shares to your pile of Shell.
And lastly, if Shell raised its dividend by 7% in 2017 to $4.31 and you reinvested at $84 per share, there would be 9.28 more shares coming your way.
Note: These kinds of projections are more art than science. It is impossible to guess the dividend growth rate, reinvestment price, and so on with a very high degree of accuracy, but I tried to build some conservatism into the model by not adding dividend growth in 2014, and I also reinvested annually instead of quarterly, which slows down the compounding process a bit.
Here is what the five-year plan with Shell might look like at the end of your “five-year plan” in 2018: your 156 shares have a realistic shot of turning into 190 shares due to dividend reinvestment. Due to the power of dividend growth, the $3.60 per share payout might grow to $4.61. That means the $561 in 2013 income might grow to $875 in 2018. That’s a 56% increase in just four or five years. That’s not bad considering it required absolutely no energy on your behalf once you came up with the initial $11,000.
If you want to get in the habit of planting the kind of seeds that will give you $1,000 per year to invest in other stocks in a way that will allow you to “wash, rinse, and repeat” the process for the rest of your life, I would suggest you do the following: accumulate $11,000-$12,000 to invest (that means saving $400-$500 per month for two years), invest it into a dividend growth company that both (1) has a starting yield of around 5%, and (2) can give you a dividend growth rate 6-7%. From there, you have to wait about five years or so to get to the point where you get $1,000 per year ($2.73 per day!) just for waking up in the morning. That’s way buying $10,000 or so worth of BP, Conoco, and Shell might be at the top of the list for an income investor.
Originally posted 2013-05-30 01:33:44.
Hi Tim. Love your articles. If my mother was alive, she would have loved them too! May I suggest an article on choosing your target price to buy and another on identifying when to get out of a stock? It seems that there are a plethora of articles on what and why to buy and sell but not when.
Sure thing, Elizabeth! I have a list of about 75+ article ideas on it, and I just added your question to it! I'm glad you enjoy the blog. I'll try to do my part to provide compelling content if I'm fortunate enough to have you stick around!
Great article. Tim, instead of accumulating $11,000-$12,000 to invest, would it not be wiser to invest $500 every month in order to average down the purchase price?
Pavel, if you could do it without expenses, that would make a lot of sense. If you are dripping, you can find a lot of companies with plans that let you invest for $0-$2. Investments in $500 increments would make a lot of sense in those cases. If you are using a discount broker and have to pay $8-$10, it might make more sense to do your investing in $1,000 increments.
Great article. If only I could get my kids who are in young adulthood to see the value of your suggested approach to investing. When they think of the 'Stock Market,' they think of 'Golden-Sacks,' Enron, and Wall Street high-finance bankers and schemes, completely missing the great companies that are available to them thru 401k investments. I'm going to try to get them to read your article and begin thinking about how they are investing their 401k instead of passively allowing their employers to do their 'investing' for them.
MCR
Michael, I'm flattered. My guess is that if you can get them into a reliable business (Coke, J&J, Chevron, etc.) and let them see a meaningful dividend check (say, over $100 or so), they'll get hooked. Receiving "free" money every three months can be surprisingly addicting.
Hi Tim, another solid article – thanks.
I just added Shell to my DG portfolio (shares accumulated over the last six months or so). As a new Shell shareholder and DG investor I'm happy to hear such strong arguments for this firm!
I haven't gotten a chance to buy any Shell yet, but it's on my short list. It seems like one of the few ways you can get yield without chasing it in this low interest rate environment.
Hi Tim,
Great blog sir! Would you consider the RDS.A or RDS.B for the Roth IRA or even regular IRA?
I bought Royal Dutch Shell Class B Shares after the earnings miss this week and it is in a tax-deferred account.
Thanks for the info! I keep reading that people should buy the A shares in a rollover IRA. Gotta look more into this.
FWIW, There is no foreign tax withheld on B shares due to the tax treaty with England. The A shares are out of the Netherlands so a tax will be taken. At least that is my understanding.
I plan on buying some B shares under that premise soon for my tax-deferred account.
Thanks JB. Yeah, I understand on buying the B shares for a tax-deferred (i.e. Roth IRA) but would you buy the B shares for a rollover IRA? Whether taxes is taken out now or later, can't decide what'll have the most material negative impact.
King, your rollover IRA is tax deferred…yes?
I am no tax expert but other than the foreign tax taken on the A shares (might be 15% for all I know) I am not sure it makes a difference when the money is withdrawn during retirement.
However, I would think that the B shares over time might be worth more vs the A shares due to the foreign tax not taken. So will there be more taxes taken on the B shares because the gain is larger when the money is withdrawn ? I don't know but I am keeping it simple and sticking with the B shares.
Good luck
Thanks JB! I guess since it'll be worth more the taxes will take more. And you're right JB. I don't know what I was thinking. I'm thinking that Rotha IRA is tax-deffered since it's post-tax money and roll-over IRA is not tax-deferred.
HI Tim
Agree Royal Dutch's yield and business model make it very interesting for a long term investor. I did some more digging into Royal Dutch Shell's dividend growth and safety here:
http://totalreturninvestor.blogspot.com/2013/09/d…
Keep up the good work
I own enough COP and RDS-B shares to have my gas expense covered by the dividends. COP has been performing better in the past year. Over the next few years, I think those oil majors with a decent focus on American oil will do better. OXY is also in the process of spinning off some of its operations such as the one in California.
Hi, I would like to know how the situation has changed over the last 7 years.
Thanks, helpful stuff. Added your blog to bookmarks
What’s up, just wanted to say, I loved thisarticle. It was funny. Keep on posting!
You are one talented writer thank you for the post. Janifer Terry Kinata
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