What is dividend investing? Generally, it’s the practice of buying stocks that pay income to shareholders. That payment is called a dividend. By paying dividends, a company is rewarding its shareholders for holding their stock. Dividends are a sign that a company is financially healthy. As a result, dividend stocks are generally less volatile than growth stocks.
Dividend investing is a passive income generation strategy. Investors will buy and hold the stock just to continually receive dividend payments. Those payments can be reinvested in the company to purchase more shares or be collected as a cash payout, taxed as income. Typically, shareholders of dividend-paying stocks will reinvest dividends over time and switch to payouts after they’ve retired, to supplement their income.
The Long-Term Investing Mindset
No matter which way you look at it, dividend investing is a long-term investing approach. Since the share price of dividend-paying companies tends to be less volatile (often pacing major indices), the opportunity to profit from a skyrocketing share price is low. Instead, the true value comes in holding the stock and collecting the dividend long term. Take a look at an example:
- Stock A is worth $20 and Jim buys 10 shares. That amounts to a $200 investment (not counting broker fees). The stock price then shoots up to $40 and Jim cashes out his $400 for a cool $200 profit. He doubled his money!
- Stock B is worth $10 and pays a quarterly dividend of $0.20. Jim buys 10 shares and chooses to reinvest the dividend. The share price increases by 8% annually for the next 20 years, but the dividend has remained consistent. Jim’s investment is now worth $1066.20 and he’ll have more than double the number of original shares he started with (22.88)!
Aside from the obvious value of holding long-term, dividend stocks also tend to be “set it and forget it” stocks. Because shareholders shouldn’t be worried about buying and selling or timing the market, these stocks will simply sit idly in a portfolio, generating wealth.
Types of Dividend Investing Strategies
The concept of dividend investing is generally straightforward. But, there are several different sub-strategies investors can lean into.
What is a dividend investing strategy? It’s simply about choosing specific types of dividend stocks to control risk and reward within your portfolio. For example, someone may choose to hold dividend-paying stocks from one sector of the market (like Utilities) for a higher-risk, high-reward dividend strategy. Others might diversify their holdings across sectors or focus on certain blue-chip stocks.
When it comes right down to it, there are three specific dividend investing strategies to explore.
What is Dividend Stock Investing?
Dividend stock investing is picking and choosing several dividend-paying stocks and focusing exclusively on these companies within your portfolio. Choosing a handful of stocks means being able to allocate more funds to fewer companies, increasing the number of shares you own and the total value of the dividends paid to you. Picking the right stocks is key. Some of the best dividend paying companies are called the Dividend Achievers. The downside of this approach is less diversity: If one of your stocks takes a hit, a larger segment of your portfolio is affected.
What is Dividend Growth Investing?
Dividend growth investing is similar to general dividend stock investing, only the focus is on companies that are expected to raise their dividend over time. For this strategy, it’s paramount to look at the Dividend Aristocrats and up-and-coming companies with at least a decade of healthy dividend payments. Investors assuming this strategy can count on a stronger dividend year over year, backed by a company that’s financially healthy and responsible.
What is the Dividend Basket Approach?
This strategy is perhaps the simplest form of dividend investing. It involves buying into a high-dividend ETF or index fund and reaping the dividends paid from this fund. Investors get the right combination of exposure to mitigate their risk, while collecting a healthy dividend. The downside is that you have no control over the stocks owned within the ETF. Also, there are usually management fees associated with ETFs.
What is REIT Investing?
Real Estate Investment Trusts (REITs) are real estate stocks that offer a high dividend by nature. REITs tend to be more volatile than traditional securities, raising and lowering their dividend as their balance sheet becomes more or less levered. These companies will always pay a dividend, but it’s not likely to remain consistent. REITs are a high-risk, high-reward type of dividend investment.
The Chief Benefits of Dividend Investing
Dividend investing is an extremely attractive investment strategy for people who are more risk-averse or who have a long-time horizon ahead of them. The benefits are many:
- Dividends can be reinvested to increase share ownership or collected as income.
- Owners can purchase more shares without any out-of-pocket capital expenses.
- Dividend stocks offer more stability and less volatility.
- Companies offering dividends are generally self-sustaining via operational capital.
- The prospect of rising dividends, amounting to more passive income.
- Fewer taxes paid as opposed to frequent trading, which incurs fees and capital gains.
- Dividend-paying stocks can be a hedge against inflation.
- Dividend investors will continue to see a profit from dividends, even in a bear market.
The Right Strategy For Long-Term Investors
The longer you’re willing and able to hold a healthy dividend stock, the larger the benefit. The compound reinvestment of dividends, coupled with the continued purchase of more dividend-paying shares means rapid accumulation of wealth. And, some day when the time comes to turn off reinvestment and collect dividends as passive income, the more generous the payout will be.
Access our free reinvestment tool here: Dividend Reinvestment Calculator.
Good investing,
Robert
