Just like any other stock, dividend stocks have advantages and disadvantages. Of course, monthly, quarterly, semi-annual or annual dividend payouts/returns on investment (ROI) are very tempting as there is a potential for the money to compound over time. However, every investor should be aware of what to look for when buying a dividend stock.
In the following article we will show you the advantages and disadvantages of dividend shares, which you should consider before buying a share.
A dividend share is a type of security that distributes part of its income to shareholders in the form of dividends. Dividends are usually paid monthly, quarterly, semi-annually or annually. The amount of the payout depends on several factors, including the company's profits or liquidity.
Especially in times of low bank interest rates, dividend stocks can be a good way to counter inflation and build up a steady income over the long term.
There are various ways to invest in dividend stocks. For example, by buying individual shares or investing in funds (ETFs) that focus on these dividend stocks.
As a rule, dividend stocks offer more security and stability than ordinary shares because of the regular distributions. Many investors assume that companies that regularly pay dividends are less risky than comparable companies that do not distribute shares, as there is a high probability of a steady cash flow.
However, dividends are also a sign of stability, because dividends can only be paid out if companies have a high cash flow and are profitable. This is often one of the reasons why these companies are considered by investors to be particularly future-proof.
Dividends are also regular income streams that can help balance the volatility of a portfolio. In addition, reinvestment can increase an investor's return over time.
As already mentioned, there are many reasons why investors choose a company that pays dividends. We list the most important ones here:
In times of an uncertain and turbulent market, dividend stocks are less likely to decline in value than non-dividend stocks because paying dividends speaks to a company's financial health and stability. In addition, the volatility of the portfolio decreases due to the constant flow of income and the associated returns that dividend stocks generate.
Historically, companies that pay dividends grow better than those that do not. This may be due to the fact that companies that pay dividends are generally considered to be more stable and therefore more investors invest in these companies. In addition, recent research indicates that companies that consistently increase their dividends perform better than those that do not. These are all factors that indicate that dividend stocks are a good long-term choice.
Dividend shares are a relatively safe investment. Companies that pay dividends usually have solid balance sheets and are able to generate a constant cash flow. This allows them to pay out cash to shareholders while investing in their business
The passive income that dividends provide makes it possible for investors to achieve greater financial stability. Whether for retired people or others, dividends offer a good way to supplement income over the long term. In addition, dividends can provide a hedge against inflation. While share prices can rise and fall, dividend payments tend to remain stable, providing investors with a reliable source of passive income.
By reinvesting the dividend payments, the returns can be increased in the medium to long term. This has a similar effect to compound interest, because the longer I reinvest my money, the more money I have invested in dividend stocks and the more money I receive in the end. In addition, companies often offer a discount on shares purchased under dividend reinvestment programmes, which can further boost returns. And if the company's share price goes up over time, so will the returns.
Dividends tend to be less unstable than the stock market as a whole. As an example: In the period between 2007 and 2017, most dividends remained stable, while the S&P 500 index had a total return of minus 2%. This is because dividends are paid out of after-tax profits and are therefore less susceptible to fluctuations in corporate wealth. Investors who want greater stability should therefore consider dividend stocks.
Inflation is always a risk for investors as it can erode the value of their investments over time. However, dividends can provide a hedge against inflation as they offer a regular income stream. As mentioned above, dividend stocks are typically less volatile than other types of securities and can also offer long-term growth potential. For these reasons, dividend stocks can be a valuable part of any investment portfolio. We have already had a blog on this topic, which you can find at here.
A study by the National Bureau of Economic Research (NBER) found that dividend stocks suffered less than non-dividend stocks during the financial crisis of 2008 and 2009. The NBER study also found that dividend payers were less likely to default on their debt. Other studies have shown that dividend-paying stocks outperform non-dividend paying stocks over the long term. For example, a study by Dimensional Fund Advisors (DFA) found that dividend payers outperformed non-dividend payers by 2.5 percentage points per year from 1972 to 2011.
Dividend shares also have potential disadvantages, which we do not want to neglect here. For this reason, we have also compiled the most important factors for you here:
With dividend shares, it is important to note that the dividend payment is usually linked to the share price. When the share price rises, in most cases the dividend payment also rises. However, there is a limit to how much the dividend can increase. For example, if a company only increases the dividend by 0.3% each year, no matter how much the share price rises, then the upside potential for that particular investment is limited.
For most investors, dividends are often only enough to finance small regular expenses. Unless a very large sum has been invested in dividend-paying shares, it is difficult to finance one's livelihood through shares. In addition, many dividend payments are sporadic and the amount paid out in these dividend stocks can fluctuate from year to year. This makes planning for retirement or other long-term financial goals difficult.
When markets are booming, dividend stocks perform better. But when the economy falters, the returns from dividend stocks can diminish. This is because a recession causes companies to cut their dividends to save cash. As a result, dividend stock investors' returns may decline during a recession.
One disadvantage of dividend stocks is that they may not offer the same growth potential as other types of stocks. For example, a technology stock may grow much faster than a dividend stock simply because the technology sector grows faster. This means that investors seeking rapid growth may be better off investing in other types of shares than dividend stocks.
Before investing in dividend stocks, there are a few other things to consider.
The first thing is to ensure that the company is healthy and profitable enough to pay dividends on a continuous basis.
It is also important to research the stock market and find dividend stocks that are undervalued compared to their peers.
In summary, dividends are an exciting option for any investor. Often, companies that pay dividends do not offer the opportunity for leapfrog growth, but they are among the most stable companies in the market. The passive income of dividends is a good way to pay for smaller regular expenses, such as a monthly mobile phone contract. In addition, dividends are often a stability factor that can provide a relatively reliable income even in times of crisis.
Attention, this is not investment advice, but solely the opinion of the author!
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