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Although safer investments tend to come with lower average returns, dividend-paying stocks have outperformed the average market return [PDF] in the long run. The ups and downs of dividend investing The potential for double profits in share price appreciation and dividends is understandably an attractive benefit of dividend investing. This, to a certain extent, also protects you against bad markets, owing to the fact that dividend-paying companies usually offer reliable income streams.
A company like Coca-Cola has been paying out quarterly dividends for decades now without interruption. Companies also tend to increase their dividend payouts every year, leading to a rising dividend yield and stockholders receiving more money without having to buy any extra shares. Coca-Cola has been steadily increasing its dividend payout since Source: Macrotrends. Blue-chip companies are large, well-established companies, and they are generally considered to be safer investments.
A few critical downsides to dividend investing also cause many investors to stay clear from this strategy. Investors looking for great share-price appreciation will likely be disappointed and will be better off looking at other stocks. Another downside is possible sector concentration in a portfolio as many dividend-paying stocks are active in the same sectors. This can lead to trouble when a particular sector hits a rough patch that might even lead to dividend cuts. An example of this is oil giant Royal Dutch Shell cutting its dividend for the first time since the second world war during the Covid pandemic.
So, the ups and downs of dividend investing are: The PROS of dividend investing: Potential of double profits: share price appreciation and dividends; Companies usually increase their dividend yearly; Generally stable companies with good fundamentals. The CONS of dividend investing: Limited upside potential for the share price; Possible sector concentration in portfolio; Companies can choose to cut or scrap dividend entirely. Mistakes to avoid as a beginner Dividend investing requires more than just sitting back and cashing cheques, and there are many things to take into consideration to do it successfully.
Unfortunately, many of these things are often overlooked by beginners, leading to painful mistakes. One of those mistakes is looking solely for a high dividend yield and not considering why the dividend yield is so high. A high dividend yield often means a low share price, which in turn signals a lack of confidence among investors.
It turns out that often a very high dividend yield is a valuable signal a company might be about to cut or scrape its dividend entirely. Apple AAPL has been steadily increasing its dividend payout since Thus, it is critical to stay up to date with news about the business and its financials in order to have a clear picture of what is going on.
One cannot maintain dividend payments in the absence of strong and consistent cash flow in the business. As a result, dividend-paying equities are often issued by businesses with large profit margins. High margins are unlikely if a company lacks profitability, so choosing companies with good earnings growth is essential.
A company can have outstanding financials, but buying it at a high valuation can still lead to a bad return. During the Covid pandemic, for example, some pharmaceutical companies saw a sizable increase in revenues. This led some to either increase their dividend or pay a one-off bonus dividend to their shareholders.
Dividend investing can be a good strategy for patient investors looking to build a passive income stream. A benefit of this is its protection against bad markets, especially since dividend payments usually continue during market turmoil. And you must invest in dividend vs growth stocks. No, not at all. I want to present a balanced argument. May not be right for you. On the other hand, I have to start somewhere. So, here goes… What Is Dividend Investing?
In the broadest sense, dividend investing simply means buying and holding stocks that pay dividends. Next, and getting more specific, a dividend investor will typically emphasize one or more of the following objectives… First, receiving a consistent stream of dividend income from stocks right now. Second, growing that dividend income stream larger and larger over time.
Third, realizing capital appreciation. From rising stock prices over the long term. Many dividend investors seek to balance these 3 objectives by investing in dividend growth stocks. While others emphasize one objective over the other. For example, an investor focused on creating the largest amount of dividend income right now. Will lean toward selecting stocks with high dividend yields. On the other hand, an investor seeking a balance between current income, growth of that income, and capital appreciation.
Would be more likely to choose stocks with lower dividend yields. Furthermore, choosing lower dividend yields from companies with a strong growth track record. Of increasing the value of their dividends paid to shareholders each year.
That has lower growth prospects due to the decline in smoking. By investing in Altria, investors earn high dividend income right away. But will likely sacrifice the potential for large dividend increases. In addition to the lesser likelihood for increases in the price per share. Real estate investment trust stocks also fall into the higher dividend-yielding lower growth category.
They are a popular choice by many dividend investors. On the opposite end of the spectrum, we also have low dividend yield stocks. But management increases the dividend rate per share every year. So, dividend investors seek out stocks like Apple for different reasons. They receive cash flow from dividends right away. But, longer-term, Apple investors desire dividend increases and share price appreciation. Finally, there are examples of many stocks that fall somewhere in between these two extremes.
Also, offering consistent increases to their dividend rate per share every year. You can also identify and invest in dividend stock funds and ETFs. That pursue a dividend investing strategy. The objectives of each fund will be different. Some will pursue high income. While others will pursue growth and dividend income. And you can find everything in between. As they assess what dividend payers to add to their investment portfolio.
The value of annual cash dividends an investor will receive. Expressed as a percentage of the amount invested. Dividend growth rate. Represents the percentage rate at which management increases the dividend annually. Dividend history. The length of time a company has been paying dividends. And for how many consecutive years the dividend has been increased. Dividend Kings and Aristocrats are stocks with excellent dividend histories.
They are a great place to start when building out a dividend portfolio. In the form of dividends. Also expressed as a percentage. Typically, a lower dividend payout ratio is better. Indicating a company can withstand difficult economic conditions. And continue to pay their dividend without interruption.
Dividend stocks tend to outperform growth stocks in a bear market. Because the dividend yield rises as the stock price falls. Thus, providing support from further declines. To receive cash from a dividend portfolio. There is no need to sell shares. Dividends are passive income that you can do as you please with. And those dividends are particularly attractive when interest rates are low. Dividends are taxed at lower tax rates. Versus income earned from your job.
Known as ordinary income. Finally, if dividend investing interests you. For selecting the best dividend-yielding stocks. And buying them at the best times. Simply Investing is an excellent tool. Although dividend payments receive preferential tax treatment. In the form of lower tax rates. Taxes are due in the year in which dividends are received. Even if you reinvest the dividends back into the stock.
So they can reduce or suspend their dividend payment at any time. Although the best dividend stocks rarely, if ever, do so. Many dividend stocks are clustered in similar stock market sectors and industries. So, it can be more challenging to build a diversified investment portfolio.
What Is Growth Investing?
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