Dividend stocks are one of the top stock investment strategies as they can provide supplemental income for present-day expenses OR be used to build towards long-term wealth goals through a reinvestment strategy.
No matter your goals with investing in dividend stocks, you’re typically going to enjoy much less volatility. We consider blue chip stocks with dividends to be among the best stocks to invest in for beginners.
However, you need to understand both the upside and the downside of any potential investment, which is why we’re going to unpack the pros and cons of dividend stocks for you here today.
While there is a lot to love about these stocks, their returns can be much lower than those associated with aggressive investment companies. And although there are plenty of safe dividend stocks, investing in high-yield dividend stocks can sometimes be a trap.
Don’t worry – we’ll show you how to get started investing in these types of stocks with confidence using VectorVest, the best stock research app available for new and seasoned investors alike.
It tells you what to buy, when to buy it, and when it comes time to sell it and find another opportunity. It will save you time and stress while empowering you to earn higher returns – so get started with a stock analysis free today!
What are Dividend Stocks?
First things first, what are dividend stocks? These are shares of companies that regularly distribute a portion of their earnings to shareholders in the form of dividends.
One of the most common questions is how often are dividends paid? Typically it is quarterly, although some companies may opt for monthly, semi-annual, or annual distributions. It’s important to align the payout schedule with your investment goals.
Companies that pay dividends are usually well-established with predictable profit patterns and a stable financial foundation. This allows them to confidently share profits with investors without jeopardizing their operational needs or growth plans.
These companies tend to be at or near maturity, which is one of the main differences between growth vs dividend stocks. This means that they are inherently safer, but you also won’t get to enjoy anything like the 3,000% growth rate we saw with NVDA over the last 5 years.
You need to understand the two main attributes before investing in dividend stocks:
- Dividend yield: The dividend per share divided by the stock price
- Payout ratio: The proportion of earnings paid out as dividends.
We’ll talk more about this later on as we get into some tips on how to live off dividends. But first, we need to find out whether or not this is the right investment strategy for you by going over the dividend stocks pros and cons.
Pros and Cons of Dividend Stocks
To put it simply, dividend stocks are a great source of stable income for long-term wealth management, but they usually won’t offer substantial returns in terms of stock price appreciation. Here’s a deeper look at the pros and cons of dividend stocks…
Benefits of Dividend Stocks
- Steady Income Stream: The regular income dividend stocks provide can be particularly compelling for those looking to invest after retirement or those seeking a steady cash flow to supplement their income. Dividends can also be reinvested to purchase more shares, compounding the returns over time.
- Sign of Corporate Health: Companies that can afford to pay dividends are typically stable and established. A consistent history of paying dividends can be a good indicator of a company’s financial health and operational stability, suggesting it’s less likely to experience severe volatility.
- Inflation Protection: Many companies increase their dividend payouts over time to help investors keep pace with inflation, preserving the purchasing power of their investment income. They are one of the best hedges against inflation, in fact!
- Attractiveness During Market Downturns: During periods of market uncertainty, dividend stocks often become more attractive because investors value the income stability they provide. This demand can help support the stock price when growth stocks might be falling out of favor.
- Tax Advantages: Dividends are taxed at a lower rate than other forms of income in many jurisdictions, such as wages or interest income. This makes them a tax-efficient way to generate income.
Drawbacks of Dividend Stocks
- Opportunity Cost: High-dividend stocks typically offer less capital appreciation, so you’ll miss out on more substantial growth opportunities through non-dividend-paying stocks.
- Dividend Cuts and Suspensions: Dividends can be reduced or suspended entirely if a company faces financial difficulties. This can be a double whammy as you not only get less income, but it can also cause a sharp decline in the stock price through negative market sentiment.
- Overexposure to Economic Cycles: Sectors known for high dividends, like utilities or real estate, can be heavily influenced by economic cycles. These sectors may underperform during a market downturn, leading to both reduced dividend income and capital losses.
- Tax Liability: Yes, dividends can be tax-advantaged – but they still create a tax liability. On the other hand, unrealized capital gains are not taxed until the asset is sold.
- High Payout Ratios: New investors often fall victim to the trap of a very high, unsustainable payout ratio. This may indicate that the company is not reinvesting enough back into its business, hindering future growth.
So, Should You Invest in These Types of Stocks?
So, are dividend stocks worth it? Just as with the pros and cons of swing trading, only you can determine if this strategy aligns with your unique goals.
Think about not just your financial goals but also your risk tolerance and investment horizon. If you want steady income and lower volatility, dividend stocks are an appealing option. They can provide predictable returns and help stabilize a portfolio during market fluctuations.
However, if your goal is capital appreciation and you have a longer time horizon, you might want to consider growth stocks or a diversified mix that includes both growth and dividend-paying stocks.
Those concerned about market dips and economic downturns can incorporate dividend stocks into a broader, diversified portfolio for the best balance of risk and reward.
Tips on Investing in Dividend Stocks With VectorVest
Whether you’re looking to learn how to build a stock portfolio from scratch or you want to supplement your existing portfolio with dividend stocks, here are some tips on getting started.
Start With Industry Leaders
We suggest a blue chip investment plan where you focus on companies with leading market positions within their industries. They often have established business models and long histories of profit, making them more likely to maintain and grow their dividends.
Assess Dividend Yield and Growth
Like we said earlier, dividend yield is among the most important considerations in your stock picking strategy. Remember that there is a balance to be struck here.
An exceptionally high yield can sometimes be a red flag for financial instability or a dividend that may be unsustainable. Companies with moderate but growing dividends may offer better long-term benefits through compounding returns.
Evaluate Financial Health
How can you be sure the company you’re eyeing will continue supporting a strong dividend? Simple – conduct fundamental analysis on the stock! Analyze key stock market indicators such as payout ratios, debt levels, earnings stability, and cash flow.
A payout ratio under 60% is generally seen as sustainable, but this can vary by industry. Solid earnings and cash flow indicate a company’s ability to continue paying dividends regardless of economic fluctuations.
You can learn fundamental analysis in our blog, or better yet, how to combine fundamental and technical analysis for a more thorough understanding of an opportunity.
Don’t Forget Diversification
While these types of stocks are inherently safer than stocks with high volatility, you should still put risk management tactics in place, such as diversification.
This can reduce risk and exposure to any single economic event or sector downturn. Combining industries with different economic sensitivities and dividend payment schedules will stabilize returns and reduce portfolio volatility.
Use Reinvestment Strategies
As we discussed in the dividend stocks pros and cons, reinvesting dividends to purchase additional shares can dramatically compound your returns over time.
So, consider setting up a dividend reinvestment plan (DRIP) if you’re not reliant on dividend income for current expenses. This automatically purchases more shares, sometimes at a discount, without incurring transaction fees.
Monitor and Adjust Regularly
The economic landscape and individual company performance can evolve over time, for better or worse. Regularly reviewing your investments will ensure they continue to meet your financial goals and adjust your holdings as necessary.
This includes selling stocks that cut or eliminate their dividends and reinvesting in more promising opportunities. We have advice on when to cut losses in our blog if you’re having trouble letting go of an underperformer.
Work Smarter, Not Harder, With VectorVest!
If after reviewing the pros and cons of dividend stocks you decide to start trading them, great! If not, that’s ok too – there are plenty of other great ways to invest in the stock market. No matter your strategy, VectorVest is among the best stock apps for beginners.
Our stock trading system is all based on 3 simple ratings that boil down complex technical indicators into easier-to-understand metrics. They are relative value (RV), relative safety (RS), and relative timing (RT).
Each sits on a scale of 0.00-2.00 with 1.00 being the average, which makes interpretation quick and easy. A rating above the average indicates overperformance in a given category.
Better yet, you’re given a clear buy, sell, or hold recommendation for any of the 16,000 stocks we track and rank on a daily basis – effectively eliminating guesswork, human error, and emotion from your decision-making.
Whether you’re interested in finding undervalued stocks right now, the biggest dividend payers, falling stocks to buy, the best swing trading stocks, the best stocks to day trade, or anything in between, the system also has pre-curated stock picks for your review on a daily basis. With the best stock picker in your arsenal, you never have to search far for your next trade.
Learning how to analyze stocks with traditional techniques is time-consuming, unreliable, and confusing. Why work harder when you could work smarter with the #1 stock market software just a few clicks away? Learn more about what our stock advisory can do for you today!
