- A balanced and diversified portfolio is key to maximum returns.
- Investing in dividend stocks is a great way to generate a stream of stable passive income.
- Dividend stocks should be given higher preference as you grow older, as it offers less returns than growth stocks, but with greater stability.
Investing in dividend stocks or dividend yield stocks is a common practice of investors. Companies which pay regular dividends to its investors are much in demand as they make investors their partners in the profits they earn. Dividends are a part of profits that are distributed by the company among its shareholders, and it is a great source of regular income for those who invest in stocks.
Although experts feel dividend payments are not so significant in the short term, but they can benefit investors if they plan their portfolio well. Dividend stocks, in most cases, can create a sizable passive income stream, which can in turn be reinvested to generate more income, and this process of compounding can lead to growth of one’s portfolio. Protection from shocks during the times of market volatility are also provided by dividend stocks, as they tend to fall less than growth stocks during these periods. Companies issuing dividend stocks usually have very sound and well-built track record, thus making it a safer bet for risk-averse investors.
Also read: 10 exciting FTSE dividend-paying tech stocks
Should you invest all your money in dividend stocks?
The answer is no! Dividend stocks offer a regular income stream via both stock price appreciation as well as payouts made by the company. Non-dividend stocks are considered riskier than dividend yield stocks, but dividend payment alone shouldn’t be considered to judge an investment option. At any time, a company may decide to reduce or even stop its dividend payments. Also, rising taxes on dividend earnings make these stocks less attractive for the investors. Given the importance of investor confidence, any reduction in the regular dividend payment may result in a sharp fall of the stock price, thus creating double trouble for dividend stock investors, who lose on both dividend as well as capital.
Another misconception about dividend stocks is that higher yield is always better. We can describe the yield as the measure, by which an investor can calculate how much dividend a company will pay vis-à-vis its stock price. Higher measure doesn’t mean the stock is stable or better, as the ratio depends of price fluctuation.
Also read: Top five high dividend-paying FTSE stocks
It is, therefore, very important to first analyse the reason behind the fall in stock price, or else investing in such stocks can prove to be counterproductive. Thus, it is important to check the track record and consistency in dividend payments of the company.
Growth Stocks vs. Dividend Stocks
To increase your chances of accumulating more capital quickly as a young investor, you should choose growth stocks over dividend stocks. If you are working, more capital appreciation should be given higher priority over the dividend income. A gradual shift can be made from growth stocks to dividend stocks as retire, and you are looking for steady passive income source.
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If you are under 40, investing all your money in dividend yield stocks might be a suboptimal investment strategy, due to limited growth options. Companies that pay out higher dividends are typically not reinvesting money into the growth of their business, and instead distributing it among the shareholders, which might not be fruitful in the long run as it lowers the equity value of the company.
Dividend-yielding stocks underperform in a rising interest rate market, while they perform better in a low interest rate environment. Companies offering dividend stocks, which can generate a consistently good cash flow, will be favoured by the investors when interest rates are low. But, even when interest rates are low, growth stocks can perform better as the growth companies can borrow at a cheaper rate and invest more in the growth of the business, which will in turn lead to higher overall returns. Thus, it’s a win-win for the growth stocks, as they perform quite well in high interest rate environments too.
It is very important to design your investment portfolio in a way such that your active and passive stock investments are balanced according to your age and earning capacity. For example, if you are under 30, you should invest all your money in growth stocks, but when you touch 40, you should invest 10% of your money in dividend stocks as well. As you are in your 50s, this 10% can increase to 20-30%, reducing your growth stock investments further. At the time of your retirement, around 60% of your portfolio should comprise of dividend stocks, as they are a safe passive income source which can provide stability in old age. As risk appetite falls with age, the exposure to volatility should be avoided, but still investing a certain proportion of your total investments in growth stocks is advisable for diversification as well as higher returns.
Also read: Does FTSE 250 pay dividend?
It is important to establish a suitable net worth allocation by age, and building a substantial financial nut quickly is difficult with just dividend stocks. Thus, other investment options should also be explored to create a diversified portfolio for maximum income and capital growth, as per your financial goals and financial situations. Dividend stocks make more sense as you grow older, while building capital should be the priority if you are a young investor.