When you decide to invest your hard-earned money, you need to take several factors into consideration. Of all the factors, your investment objective, risk preference, and the time horizon of investments are called the three critical pillars of investing. In the current market, investing in stock markets allows investors to give themselves a good opportunity to earn returns. However, in order to meet your financial goals, it is important to choose the right stocks. In today’s article, we will be focusing on dividend investing for investors who seek to create a stream of regular income along with the growth of their portfolio’s market value.
What is Dividend Investing?
While investors seeking regular income would traditionally invest in fixed-income securities, these instruments have been offering relatively lower returns in recent years. Therefore, most investors are turning to the stock markets to find the right balance between risk and returns as well as meeting their financial goals.
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In Dividend Investing, investors choose stocks of companies which pay good dividends to generate a steady stream of income. If we take a quick look at the market, older and more established companies are the ones who usually offer good returns. Further, several research reports have also shown that dividend-paying stocks tend to do better than non-dividend-paying stocks in the long run.
Pros and Cons of Dividend Investing
While the dividend investing strategy has been used by many investors over the years, is it really a good choice? Let’s look at the pros and cons of dividend investing and find out for ourselves:
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Dividend Investing |
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| Pros | Cons |
| An obvious benefit of investing in dividend stocks is that you receive regular money from the company. Unlike investing in newer companies, these organizations are usually established and you do not have to wait for them to capture the market and increase their stock price. You receive regular income periodically | There is no law which prohibits a company from reducing or even eliminating dividends. Since dividends are paid when the company books profits, they can go down when the profits go down. Also, profits can reduce because of a variety of reasons. |
| Even if a company reduces dividends occasionally, it is more common to see such companies increase their dividend amounts. | Usually, companies offering dividends are the more established large-cap companies from the utilities or old-school business sectors. Therefore, investors opting for dividend investing, tend to miss out on the promising small-cap companies which can become the next big thing in the market and make a huge profit. |
| Many experts suggest that dividend-paying stocks tend to offer returns similar to those offered by the market as a whole. Also, these stocks have lesser volatility and hence considered safer. The price of such stocks increases slower as compared to the other stocks but it also tends to be more resilient to market volatility. | Despite dividend stocks being safer, they are not as safe as bonds. If the market takes a bearish turn, then prices of dividend stocks will also suffer the heat and go down. |
Factors to keep in mind before you opt for Dividend Investing
If you feel that dividend investing is right for you, then keep the following tips in mind before you opt for it:
Dividend Safety
Let’s say that a company earns $500 million as profits. Now, let’s imagine two scenarios:
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- The company pays out $150 million in dividends
- The company pays out $450 million in dividends
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If you were to choose between both these scenarios, then you should opt for the company who pays $150 million out of $500 million (approximately 30%) in dividends. In fact, most successful dividend investors around the globe do not prefer companies who declare more than 60% of profits as dividends. The reason is simple, if the company experiences a drop in profits by 10-15%, then the management might not have any leverage room.
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Dividend Growth Rate
The primary objective of dividend investing is to collect a basket of stocks which offers a high dividend yield. Usually, investors start looking for stocks which are offering good dividends and try to join the bandwagon by investing in them. While this can work well, many other investors look at the dividend growth rate of a company.
Let’s say that a company is currently paying dividends which are lesser than the average dividends offered by similar companies. However, it is growing fast and within 5/10 years it might surpass the dividends offered by others. Many investors buy the stocks of such companies by analyzing their growth rates.
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Do not invest solely based on Dividends
While dividend investing focuses on selecting companies which offer good dividend payments, you should resist all urges to invest purely on the basis of the dividend offered in recent times. Remember, every time a company pays dividends, it retains lesser earnings with itself. Therefore, you must look at companies which offer a good dividend yield.
Dividend Yield = Annual dividend per share / Price per share
Also, make sure that you spend some time researching the company before buying its stocks. Look for companies who balance dividend pay-outs and reinvestments in the business optimally.
Summing Up
Before we sum up, you must also consider tax implications (if any). At the end of the day, you must endeavor to create an investment portfolio that helps you achieve your investment goals easily. You can talk to an investment advisor to help you create a strategy for dividend investing. We hope that this article can help you in making a more informed decision. After all, every investor is different and you need to decide if dividend investing is a good choice for you. Good Luck!
