When I started investing, I didn’t know about dividends. In fact, the only thing I knew was that you’re supposed to buy stocks when the price is low and selling them when the price is high. The first time I found out, was when I looked in my brokerage account and had a notification that I made $2.50 from a dividend payout. I thought to myself, “What’s that?” and thus started my dividend education!
What is a dividend?
A dividend is a payment issued by a company to its shareholders out of its profits. Rather than reinvesting all of the company’s profits into its business, it pays out a portion of those profits to all of the shareholders as a reward for owning shares.
Stocks that pay out dividends are often referred to as Income Stocks. Income Stocks are usually well-established stocks.
So now that you know what a dividend is, you may be asking yourself, “Why should I buy dividend stocks? Let’s go over that next.
Should I Buy Dividend Stocks?
I believe that if you meet any of the three criteria below, dividend stocks would be a great addition to your portfolio.
- Do you want recurring income?
- Do you want to invest in low-risk and well-established companies that have proven themselves?
- Are you a retiree or soon-to-be retiree?
With dividend stocks, you will receive paid dividends regularly. Often, these are issued quarterly but there are some companies that pay them out semi-annually. Every company is different and when the payout is determined by their own schedule.
Income Stocks are usually well-established like I mentioned which means they are generally not in the Growth Phase of their development. As a result, they are not reinvesting all of their revenue back into their growth or incurred debt.
They are usually positive cash flow businesses which means they are safer in general. As a result, they don’t generally rise or fall in price very rapidly. Although they may slowly rise or lower in value, the majority of their value comes from this low-risk issuing of dividends.
If you are a retiree or soon-to-be retiree, having a stable portfolio is important since volatile stocks can lower in value at the worst of times such as when you are depending on the interest generated from a retirement account to pay your bills. Growth stocks are usually very dangerous in retirement accounts that are near maturity or at maturity.
Advantages of Dividend Stocks
- They provide income – Even if a stock is trading sideways and doesn’t seem to rise in value, dividends offer dependable income which leads to profitable investments.
- Price Stability – Dividend stocks tend to be more stable since they are often “blue chip” stocks that have a long history of performance.
- Stock Price Appreciation – Even if you are receiving a consistent dividend, there is still the chance that the stock price will rise. If it does rise, you benefit from the appreciation as well.
- Special Tax Rate – Depending on your income, you will pay a Qualified Dividend Rate rather than paying the full tax bracket rate that you utilize for your other income.
- Dividend Reinvestment Plan (DRIP) – Rather than take out all of the income from dividends, you can reinvest it and allow it to grow faster.
Disadvantages of Dividend Stocks
Now that you’ve seen the advantages, let’s check out the disadvantages:
- Reduced Growth – One reason dividend stock companies tend to grow at a slower pace is because they pay out dividends. Growth companies tend to reinvest their earnings right back into the company.
- Low Growth – As mentioned previously, dividend stocks grow slowly due to their lower volatility. As a result, the payment is usually pretty modest as well. That means you will make income but it probably won’t be earth-shattering.
- Dividend Amounts Are Not Guaranteed – A dividend rate can be reduced if earnings are down as well. This type of risk can be minimized by choosing Dividend Aristocrats (companies that have a record of historically raising dividend rates each year).
- They can be affected by interest rates. If interest rates rise, other fixed-income investments may be more enticing which could affect the value of dividend stocks. Also, rising rates can affect the company’s revenue and cause them to cut dividends as well.
Alternatives to Dividend Stocks
If you are looking for something similar to dividend stocks, there are a few alternatives that you may consider.
- The first alternative is Treasury Bonds. These offer a fixed rate of return and are government-issued bonds.
- Next, consider Certificates of Deposits. These are effectively loans that you provide to a bank in exchange for receiving your money back in a few years with interest. Banks will offer various terms of maturity and the longer time-frame you choose, the more interest you will acquire.
- Mutual Funds of Income Stocks offer exposure to income stocks without having to choose them individually. They are generally safer than hand-picking Income Stocks.
- Exchange-Traded Funds (ETFs) for Income Stocks are also a great alternative. They offer the benefits of Mutual Funds but may require less of a minimum deposit. ETFs also usually have fewer fees.
Are Dividend Stocks Worth It To You?
So, after reading this information, do you think dividend stocks have a place in your portfolio? If so, you may consider finding several dividend stocks that each pay dividends on different months.
By spreading out the dividend payout months, you create a more steady stream of income. Another way to do this, as I already mentioned is to select a mutual fund or ETF that is made up of income stocks.
Have you ever heard the term Dividend Aristocrat? I didn’t either until recently. Dividend Aristocrats are companies that have increased their dividend payouts consistently over the last 25 years! Want to see an example?
By choosing Dividend Aristocrats, you know you are investing in a company that has a firm foundation and a history of success. Dividend Aristocrats can be a great way to invest in Income Stocks early and benefit for decades.
Where Can I Start Investing in Dividends?
If you already have a brokerage that you purchase stocks through, there should be a way to find dividend stocks by filtering for them when you are searching for stocks to invest in.
For example, if you are using Webull, you an actually pull up a list of dividend stocks and sort them by dividend price or yield.
I decided to sort dividend yield between 5-10% which means that I will see stocks that offer a dividend between 5-10% of their share price.
This will reduce the list of stocks down to 370 to choose from. You can even combine other filters to further reduce the list to meet your individual criteria. Here’s how the list would look just based on the dividend yield criteria I used:
If you like how Webull’s screener looks, I’d like to invite you to read the full review that I wrote about Webull as well where I discuss all of the features and benefits that it offers as a brokerage.
I hope you found this helpful! If you have any questions or comments please add them below and I would love to stay engaged.
Until next time, Let’s Start Investing!
Eric Baglio has been investing for over ten years and learned a lot of valuable lessons along the way. He has helped numerous people start investing on their own and founded Let’s Start Investing to help anyone willing to learn how to build wealth. His favorite brokerage is Webull and his favorite stock advising service is Motley Fool Stock Advisor.