Is Dividend Investing Worth It?
Using your saved money to invest in a company’s stocks in order to gain profits on it is a great way to make money easily. It is something you can do from your saved income or your business profits to make an additional stream of money for your future. In other words, dividend investing is an ensured way of earning extra income for yourself.
In this article, we have provided you with everything you need to know about dividend investing. We have explained the strategies involved and the risks to avoid. However, first, let us have a closer look at what dividends actually are and their different types. This will help us to understand the process of dividend investing better.
Dividends and Their Types
Let us first understand what a dividend is. It is a payment made to specific shareholders of a company. This payment comes from a portion of the company’s earnings. Usually, publicly trading companies issue dividends. Generally, the board of directors of a company will set a meeting, discuss the financials, and see if a dividend is warranted. If they see that to be a good fit, they will then declare the dividend. Along with the declaration, the size, record date, and payment date are all set. Companies can make dividend payments to the shareholders on either a monthly, quarterly, or yearly basis.
There are two major types of dividends.
- Regular dividends – Paid to shareholders on a consistent basis over time.
- Special dividends – One-time payments made after a huge profit.
What Is Dividend Investment?
Dividend investment, in simpler words, is an investment in stocks that pays a dividend. A payout ratio is set, which determines the amount of payment that is to be made to the company’s shareholders out of the net income earned by the company. The payout ratio also helps to determine the income that the company is retaining itself.
Why Should One Invest in Dividends?
People generally consider a dividend investment a safe and reliable source of gaining a stream of income from stocks. Some stocks can even pay huge amounts of dividends consistently. When you invest in stocks, you receive dividend payments as long as the company can support it. This does not depend on your stock’s price being up or down.
Also, they help in your capital appreciation as well, which is basically the increase in your company’s assets’ value. Thus, they provide a more stable flow of income. Therefore, it has proven itself to be a very efficient source of earning for many investors.
Things To Look for When Investing in Dividends
Before jumping on to any decision, you must first analyze and see if you are investing in the right place. We have compiled a list of factors below that you need to check for before deciding if it is worth the investment or not.
Dividend safety is the most essential factor that you must consider before making your investment. You can seek dividend safety by looking at the dividend coverage ratio. This ratio is a metric that measures the number of times that a company can pay dividends in cash to its shareholders. A company is very likely to be a safe choice if the dividend coverage ratio is high. It will be in your favor to invest in a company that pays out at most 60% of its profits to the shareholders.
For instance, if a company earns £10 million and pays out £3 million in dividends, then it is a safer option for you to invest in. However, if the same company pays out £9 million in dividends, then it is bad news. Also, check that the company has a stable cash flow and a consistent income. Thus, this would ensure that the company is capable of paying continued dividends.
A dividend yield is a measure of the amount of money you will earn. In other words, it is the payment you will receive for every pound invested at the current price based on the current dividend rate. In order to calculate your dividend yield, you should divide your dividend cash by the share price. So, you want to look for a dividend-paying company that has high yield rates while making your investment.
However, you must be cautious of dividend traps by looking at other similar companies and checking that their dividend yields are also close. A company with a high dividend yield may seem promising, but you must always do your research before investing. In such cases, it can also at times mean that a company is deep into financial issues.
High Dividend Growth Rate
The high dividend growth rate strategy is such that investors buy stocks in a company that is paying out below average dividends at the moment but are growing very quickly. The fast growth indicates that within a few years, the company will be capable enough to pay dividends higher than they would have paid had they used the high yield strategy. Therefore, if you can be patient enough, then do look for this factor as it will help you out in the long run.
Qualified Dividend Stocks
As a shareholder, when you wish to invest in a company’s stocks, do look for dividends mentioned as qualified. This is because such dividend stocks can help you to qualify for more benefits in taxation. These stocks are held back for a longer time – at least two months – and usually get the benefit of a lower tax rate.
Many investors often overlook industry health. However, it can specify if an investment is a good or bad one. Observe the company’s history and check out its current situation. For instance, everyone expects that the healthcare services industry will grow exponentially in the next few decades as the large population consisting of Generation X will age and require increased medical care. This ensures that healthcare stocks are more likely to be resilient compared to other stock types.
We have seen it happen quite often that investors start with the dividend aristocrats or stocks that have increased their dividend payments for 25 or more consecutive years. It was started in 1989 and included around 26 companies. However, now the list has grown and includes over 50 companies. People consider dividend aristocrats a great way to start for burgeoning investors since it almost guarantees to be a safe bet. It has proven that it has durable business strategies and models which are quite able of keeping their dividend payments continuous and ensure their increase over time.
Types of Investment Strategies
Before investing in anything, it is vital that you opt for the right investment strategy. The best investment strategy is the one where you maximize your income and minimize any risks involved. The following are the four main types of investment strategies that are popular in today’s world.
Value investing is a strategy that means you invest smartly. Hence, you invest in stocks that look like they are being traded for less than their actual or book value. Value investors look for stocks that the market seems to have underestimated. They buy stocks whose prices, according to them, do not reflect their book value. Their investment takes into account a prediction that there must be some sort of irrationality in the stock market. This prediction makes them think that they are getting a high-value stock at a discounted rate. Thus, they plan to make a lot of money on it.
However, many investors seem to give up on this strategy after a few years of gaining low income. To succeed with the value investing strategy, you must be patient enough to play along for a long time.
Growth investing is an investment strategy used by those who wish to earn an income through capital appreciation. This strategy involves investing in companies with a promising future, rapid growth rate, and good health. People often say or believe that such investors are always looking out for the next big thing. They put their money after analyzing both the company’s future and current potential. However, in a growing company that needs its capital to increase its growth, there is not much left to take out for dividend payments.
This a severe drawback of opting for the growth-investing strategy. Another risk factor here could be the higher valuations that come along with faster earnings growth. Therefore, value investing outperforms growth investing in the long run. This does not mean that a growth investor cannot make profits with his strategy. It just means that he could have benefited more with value investing over time.
Momentum investing is an investing strategy where investors go and put money on the stocks already succeeding in the market. If a stock shows an upwards trend in its profits, then momentum investors tend to think that this trend will continue for a long time. They tend to be analytical thinkers, which means that they rely heavily on the data provided to them.
As a result, they let the trends in stock prices guide their investing decisions. In their heads, winners continue to win while losers continue to lose. This approach can provide great benefits or losses in many ways, but it is quite difficult to comprehend.
Pound Cost Averaging
Pound cost averaging is an investment strategy. This strategy means that you invest at consistent intervals rather than paying a lump sum amount. In this way, by investing over a period of time, you give yourself the chance to average out a consistent price in a failing market. You are able to straighten up the different fluctuations in the stock’s price over time. This helps to relax you from worrying about the right time to invest your money. It also saves you money since you can buy a share at a discounted rate in times of failure.
This strategy could really benefit you in many ways. For instance, you can buy 20 units of stock worth £5 each for £100. In the next month, the price falls to £4, which allows you to buy 25 units of the stock with your next £100 investment. Thus, now you have 45 units of the stock. Alternatively, if you had paid £200 in just one month, you would have ended up with just 40 units of the stock. So now you can see how convenient this investing strategy is.
Conclusion – Dividend Investing: A Good or Bad Idea?
With a good and suitable investing strategy, dividend investing can prove to be a really efficient way of increasing your income excessively. It is a great compounding strategy since you keep gaining more shares with each dividend payment that you receive. It is beneficial for you as an investor and also for the company that you have invested in.
There can be some risk factors involved in dividend investing, but it is a great way to ensure future gains. Thus, according to all our research, we would highly recommend dividend investing to you as an investor. With a solid strategy and long term commitment, it is possible to build a portfolio that pays a significant return each year some people live off their dividends returns. However, keep in mind that you must do thorough research before putting your money into any company. You must figure out your best suited investing strategy, and then you are good to go.