Why Dividend?

Before answering the question, you need to know what dividend is. Many investors, especially new investors, know on the surface that dividends are quarterly or monthly cash payments by certain stocks. From business perspective, dividends are the portion of profits generated by the company. The company no longer needs to reinvest all of its profits to grow the business so it returns the extra cash to investors as dividends. This usually indicates the company itself has entered into a steady growth or even mature period. If there are opportunities for it to invest and grow faster, the company will retain the profits instead of paying dividends.

Now come back to the questions, why do you invest in dividend paying stocks? Let’s see.

Advantages of dividend stocks

Provide both income and growth: When you choose the right stocks that pay dividend and increase dividend every year, you can use the paid dividends as supplemental income source and still end up with growing principals year after year. The balance between income and growth is important. You do not want to company to overstretch its financial situation by returning too much money back to investors. Buying companies with modest dividend payouts and still grow at market average return is the best strategy.

Overall are more predictable companies with higher qualities: Paying dividends is a commitment the company management sends to investors, and the company needs to have strong financial positions to continue paying dividends. Once a track record of increasing dividends is established, management usually tries very hard not to reduce dividends, which results in more careful and better decisions in running the company and capital allocation. These companies as a group end up to be above average when compared to the whole market. Their cash flows are relatively more predictable since they need increasing cash flows to payout increasing dividends year over year.

Psychological advantage - cushion during bear market: Dividend stocks are also defensive stocks because of the dividends paid, even in very bad bear market. When a company’s financial position is strong enough, the risk of cutting dividends is lower than average. The share price usually does not fall as deep as market because investors will chase the dividend yield to create buying support. You can also use the paid dividends to buy other stocks during market downturn.

Disadvantages of dividend stocks

Taxes paid on dividends: Dividends are usually taxable income. It’s recommended that you put dividend paying stocks in tax advantaged accounts like traditional IRA or Roth IRA. If you have to extra money in taxable brokerage account and still want to buy dividend stocks, you can always put lower dividend yields and higher growth dividend stocks in taxable accounts to reduce tax bills.

Not easy to get it right: Finding the right dividend stocks at the right time is not easy. Even though the best dividend stocks have predictable income and better qualities, inexperienced investors easily get tempted into buying stocks with very high dividend yield and ignore the growth component. The worst thing could happen in dividend investing is chasing yields without considering the safety of your principals. This is exactly what this website and the rating system can help you - find the companies pay sufficient dividends while have the potential to increase the dividend and sustain the growth for years to come.

How to invest in dividend stocks

Start with dividend ETFs: Dividend investing doesn’t contradict with traditional index investing. You should still put majority of your money in index funds, and start to diversify into dividend ETFs if you would like higher supplemental income. Buying individual stocks is a luxury and privileges - always make sure you know what you are doing. It’s always recommended to buy a few stocks that you know really well, and keep index funds and dividends funds to avoid missing out the market returns.

Find stocks with history of increasing dividends: The next step to find individual dividend stocks is to identify those that have been increasing dividends for many years. All stocks in the rating system of this website have a minimum 7 years of consecutive dividend increases. Otherwise they will not be included. Raising dividends is a promise from management to investors, and one responsibility you want management to always keep in mind.

Filter stocks can sustain dividend increase and high total growth: Having a long track record of dividend increase in the past is good, but it does not tell you if the dividend increases will continue, and at what rate. You need to research the dividend growth rate, company’s financial position to sustain the dividend, and if now is a good timing to add a particular stock into your portfolio. Check out the rating system and its components. Each component shows one aspect of the company and combing them together shows you a comprehensive picture of its dividend situation.