Here's How to Snag a 20% Dividend Yield

Dividends are wonderful. They typically arrive every quarter and are generally paid in both good and bad economic environments -- and dividend-paying companies often increase their payouts over time, too.

It's tempting to chase the highest dividend yield you can find, but that's not a great idea. For one thing, when a stock's price falls, its dividend will rise -- so many (but not all) high yields are tied to companies facing challenges.

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Also, just as important as the size of a dividend -- and arguably more important -- is its growth rate. A fast-growing 2% yield, for example, may eclipse a 3% yield in a few years.

If you favor dividend-paying companies that are hiking their payouts at a good clip, you can end up with a whopping yield -- eventually. Here's how: Imagine that you buy 100 shares of the hypothetical Scruffy's Chicken Shack (Ticker: BUKBUK) when its share price is $50 and its total annual dividend is $1. (That's $0.25 per quarter.) Its dividend yield is therefore 2% ($1 divided by $50.) Your total purchase price is $5,000.

Fast forward 10 years. Let's assume that Scruffy's has upped its payout by, say, 7% annually over that period. If so, its $1 annual dividend amount will have become $1.97. It would have doubled. Based on your initial purchase price, and without considering share-price appreciation, your effective dividend yield is now 4%! ($2 divided by the $50 you originally paid) Go 10 years further ahead, and the dividend may have reached $3.87 -- having almost quadrupled. Your effective dividend yield is now around 8%.

If you invest in some dividend payers with yields of 3% or more, ones that are growing their dividends more rapidly, and/or you invest for a very long time, you can achieve effective dividend yields of 20% or more -- with your stock's price appreciating over time, too.

You might also consider dividend-focused ETFs such as the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) or the iShares Core Dividend Growth ETF (NYSEMKT: DGRO).

Selena Maranjian has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Dividend Appreciation ETF. The Motley Fool has a disclosure policy.