If you want to build long term wealth by investing in the stock market, you have to consider a dividend investing strategy.
While most any investment plan will build wealth if you stick with it over the long term, a dividend investing strategy has added benefits.
In fact, by investing in dividend paying stocks, you can potentially earn a higher return with less risk.
And who wouldn’t want this?
5 Reasons Why Dividend Investing Is Your Best Friend
In this post, I’ll walk you through 5 great reasons why you need to seriously consider dividend investing as well as the best way to get started!
1. Higher Return
Historically, dividend paying stocks have outperformed the market as a whole. This is simply because, in addition to the growth of the stock itself, you get the added benefit of dividends.
When you combine these two, you have higher than average growth.
For example, let’s look at 2 hypothetical stocks, ABC and XYZ. We will assume ABC pays a 3% dividend and the stock price grows at 5% a year.
XYZ doesn’t pay a dividend and returns 7% a year.
Which investment will provide the highest long term growth assuming they can continue to grow at these rates?
The answer is ABC. When you add the 3% dividend to the 5% stock growth, you have an 8% rate of return.
And if ABC company increases the dividend as the years pass, your rate of return will only continue to go higher.
This hypothetical example plays out in real life too.
Below is a chart from Morningstar. It shows the growth of $10,000 from 1960 through 2017 invested in the S&P 500 Index.
Growing your initial $10,000 into more than $460,000 is great.
But look at what happens when you take into account dividends. In this case, dividends are reinvested to buy more shares.
The result is your $10,000 grows into more than $2.5 million!
As you can see, the impact of dividends makes a difference over time.
2. Passive Income
When you invest in dividend paying stocks, you earn income every time the stock pays you a dividend.
In most cases, this means you get paid 4 times a year. This is money you earn no matter what you are doing.
Think about it this way.
To earn money from your job, you have to show up five days a week and perform tasks.
You have to work to earn an income.
Even if you have a side hustle, odds are you are doing work and in return for that work, you earn an income.
But with dividend investing, you aren’t doing any work. You could sleep in and still earn an income.
You could play with your kids, binge watch your favorite show, or even play golf.
No matter what you are doing, as long as you own the shares of stock, you are earning an income.
And to increase your income, you simply need to buy more shares.
If this reason alone doesn’t get you excited about dividend investing, I don’t know what will!
3. Secure Future
I want to take the point above about passive income one step further. I mentioned how you earn more income when you invest more money into dividend paying stocks.
While this is true, there is another way you can earn more dividend income. This is done by simply holding on to these stocks for the long term.
Many dividend paying stocks increase the amount they pay out on a regular basis.
So even though you might own the same number of shares, you could earn more money every year, assuming the company increases its dividend payout.
And many companies do this. In fact, there is a name for the companies who have increased their dividend payments each year for the last 25 years or more.
They are called dividend aristocrats.
Why is increasing the dividend payment important to you? As you retire, inflation isn’t suddenly going to stop.
Prices will continue to rise every year.
By owning dividend paying stocks, you offset this rise in prices by earning larger amounts of dividend income.
4. Lower Volatility
Do you want to find investments that don’t fluctuate wildly in the price? Then dividend stocks are what you should be looking at.
This is for two reasons.
- Dividend paying stocks tend to be larger, more mature companies and as a result, don’t have wild price movement compared to the market as a whole.
- Investors in stocks that pay dividends tend to be ‘buy and hold’ investors. This means they don’t sell frequently and this adds a layer of stability to the stock.
While you won’t see large movements in the stock price with stocks that pay dividends, you will still see movement.
Don’t think that investing in these stocks means you will never gain or lose money.
These stocks do experience gains as well as losses. The difference is the movement is much less than it otherwise would be.
For example, look at a company like IBM. They are a large business with proven revenue streams. As a result, investors know what to expect when the company reports earnings.
Sure there are surprises from time to time, but for the most part, you know what you are getting when you invest here.
On the other hand, if you invest in a small biotech company, you have no idea when it comes to revenue. So when they make a new discovery, the stock prices take off like a rocket.
But the reverse is true too. When they have to scrap a study, the stock price sinks like a rock.
5. Long Term Focus
One of the major flaws most investors face is a lack of holding onto an investment for the long term.
When the market is rising, it is easy to stay invested. But when the market starts to fall, this is when most investors panic and sell their holdings. Many times, their fear keeps them out of the market for a long time, sacrificing amazing returns along the way.
But by investing in dividend stocks, you can lower the urge to want to sell when the market is falling.
The reason is that you are earning an income stream simply by holding onto your investment.
For example, if you own a stock that doesn’t pay a dividend, all you have to consider is the loss of principal.
But with a stock that does pay a dividend, you are still losing principal, but you are receiving an income every quarter.
This income stream gives you a reason to stay invested in the stock. And when you do this, you benefit when the market turns around and you experience the gain from the start.
How To Get Started With Dividend Investing
Now that you see how powerful dividend investing is, you are wondering how can you get started?
You have a handful of options, including investing in mutual funds and exchange-traded funds that invest in dividend paying companies.
The problem with these investments though is you cannot control the stocks they buy into. As a result, the dividend yield you earn is less than if you built your own dividend portfolio.
How do you build a dividend portfolio? You pick and choose stocks to make up your portfolio and then invest in these companies.
The problem with this strategy had been you needed a lot of money to invest because you could only buy whole shares of stocks.
For example, if AT&T was trading for $30 a share, you needed to invest $30 just to buy one share. If you wanted 100 shares, that means $3,000.And you haven’t even bought other stocks yet to diversify your portfolio!
But thanks to technology, you can now get started with fractional investing. Fractional investing allows you to buy a fraction of a share of stock.
In this case, if you had $3,000 to invest, you could spilt it between all the stocks that make up your portfolio and be instantly diversified and start collecting dividends.
To me, this is your best option. You have 100% control of the stocks you own and you don’t need a lot of money to start investing. In fact, you could start at just $100.
The only catch to dividend investing this way is to not focus only on the dividend. For me, I want to have an overall dividend yield of 3% or higher.
This means that I will keep up with inflation with my dividend income. While there are lots of dividends paying stocks that yield more than 3%, not all are worth investing in.
The bottom line is to invest in high-quality stocks that pay a healthy dividend.
At the end of the day, a dividend investing strategy is a great strategy for most investors. It allows you to earn a passive income every year and you keep volatility in check.
Of course, it isn’t all great news. When the market drops, so too will the value of these stocks.
But chances are that their values won’t fall as much as other non-dividend paying stocks.
I encourage you to seriously consider creating a dividend investment strategy so you too can reap the benefits of this type of investing.