Dividend stocks have been regarded as a cornerstone of many investment strategies. Investors who buy and hold dividend stocks have posted steady returns and have built wealth through dividend investing. In general, the pros of investing in dividend stocks far outweigh the cons and dividends help investors weather the bad times. As an investor, you should take the time to learn more about dividends and what they can do for you.
What Are Dividend Stocks?
Companies that are profitable can do various things with the money that they make. Some companies will choose to reinvest their earnings in order to fuel future growth. Other companies will retain these earnings and keep them in the corporate bank account as a way to pile up cash as future reserves.
Many companies, as a way of trying to make their corporation a more sound investment and sharing their profits with their investors, will pay some of these earnings out to their investors as a dividend. This is either cash or stock payment that is made directly to investors. Dividends can be paid quarterly or annually or even can be paid out as a special payment.
Are Dividend Stocks Good Investments?
In general, dividend stocks are a strong investment, but first, you need to do your own research on the stock to make sure that you are investing in a sound dividend company. The best dividend stocks to own are the ones that are paying you the company’s profits as opposed to simply paying you cash from the company’s account. This means that the company has a sustainable dividend that is covered by the company’s earnings. Companies cannot continue to pay money that they are not replenishing.
The dividend stocks that make the best investments are the ones that show dividend growth over the years. Not only is this a sign of company health, but it also helps grow your overall investment. There are countless stories of small investments in dividend stocks becoming large ones over decades and one of the reasons for this is dividend growth.
When a company pays a dividend, it is seen as a sign of strength and stability. It means that not only is the company profitable, but it is confident enough in its future profitability to pay out cash to shareholders. The best dividend stocks to own are the ones with consistent and stable dividends that have a chance to grow in the future.
The Pros and Cons of Investing in Dividend Stocks
The largest benefit of investing in dividend stock comes when you have dividend reinvestment. Automatically investing the proceeds of your dividend payment in new shares of the stock helps you compound your money and increases the growth of your investment. With dividend reinvestment, you do not need to do anything other than set it up for the first time.
Another major benefit of dividend investing is that you are able to receive a passive income just from owning the stock. You get paid just to be an owner with no further effort or investing on your part. You can use the dividends to either supplement your income or to reinvest. Dividends have a lower tax rate than ordinary income so you can keep more of your payments.
The downside of investing in dividend stocks is that these companies are often more mature corporations. As a result, while you may see steady returns on your investment, your stock ownership may have less upside than you would see from investing in a growth stock.
In addition, when you receive a dividend, it is not getting something for free. This is an asset of the company, namely cash, that is being given to you. This makes the company worthless and it needs to earn back the cash to restore its balance sheet. Sometimes, the company cannot make the money back, and this is when it ends up cutting its dividend. In other words, dividends are not promised or guaranteed until they are declared.
Dividend investing is a great way to grow the value of your portfolio by investing in established companies that are making money. While your returns may not be outsized, they will be steady enough to give stability and upside to your portfolio.