Get Paid As You Invest
Investing does not have to be a waiting game. In this guide we check out dividend investing, a type of income investing that focuses on companies that pay dividends to shareholders.
In essence, dividend investing aims to generate a regular income through dividends paid by the companies you own while benefitting from long term capital growth.
Another way to think of it is like owning a rental property. Rather than selling the property to make a profit, you collect monthly rental income. Dividend investing works much the same way, except that instead of tenants paying rent, companies pay shareholders a share of their profits.
How it works
When companies make profits, they can generally either reinvest them in the business, buy back their own shares, or share some of them with shareholders through dividends.
Dividend investors typically invest in companies that share these profits with shareholders. So, like planting fruit trees, you do not chop down the tree to make money; you harvest the fruit each season.
Companies that pay dividends tend to have steady cash flows and profitability, and are often mature businesses such as Coca-Cola and Nestlé.
Many of these established companies aim to maintain or grow dividend payments over time, although dividends are not guaranteed. This means investors can potentially benefit from both rising share prices and a regular income stream.
Plot twist
Over the long term, dividends have made a significant contribution to total stock market returns. Research from Charles Schwab shows that dividends have accounted for around 40% of the S&P 500’s total return since 1926.
Reinvesting your dividends can further enhance long-term returns through the power of compounding. By using each dividend payment to buy additional shares, those new shares can generate dividends of their own, creating a snowball effect over time. Your money earns more money.
How you are paid
The most meaningful way to measure the performance of a dividend investment is by looking at its total return, rather than its dividend yield alone. Dividend yield is the annual dividend per share, divided by the price per share, expressed as a percentage.
Total return, combines both dividend yield and the % change in share price. For example, a fund with a 4% dividend yield that also rises in value by 6% would deliver a total return of 10% before fees and taxes. Conversely, if the fund fell in value by 8%, the same 4% dividend would still result in an overall loss of 4%.
How to invest
Dividend ETFs and funds offer a simple, cost-effective way to access hundreds of dividend-paying companies through a single investment.
They are more suitable if you are investing for the medium-to long-term, can tolerate fluctuations in your investment value, and want the potential for both income and capital growth. You also have to be comfortable with the fact that dividend payments can be reduced or suspended.
Rather than focusing solely on which funds offer the highest dividend yield, it is best to first consider your investment strategy in its entirety, as dividend investing, exposes you to stock market risk and both the value of investments and the level of income received can rise or fall.
A successful investment strategy should be built around clear financial goals, an appropriate investment time horizon and your risk tolerance. Ultimately, one of the best ways to do this is through a well-thought-out and diversified portfolio. Do your research.
The bottom line
Many investors find that the most effective approach is not to choose between income or growth funds, but to combine both within a diversified portfolio. Dividend funds provide the regular income and help cushion your portfolio from market volatility, whilst growth-oriented funds offer the potential of capital growth.
Together, they hopefully create a resilient portfolio better able to withstand unpredictable market conditions and deliver satisfactory long-term returns.
If you are considering dividend investing but are unsure whether it is right for you then speaking to a qualified financial advisor can help ensure your investment strategy aligns with your goals and levels of risk tolerance.
Remember, the value of your investments can go down as well as up and is not guaranteed, and you may not get back the amount you originally invested. Past performance of any product you buy is not a reliable indicator of future results.
This article is not financial or personal advice. We are not financial advisers. The information contained in this article is designed for educational and informational purposes only. It is provided solely to enable you to make your own choices. Always remember that if you choose to invest, the value of your investments can fall or rise, so you could get back less than you invested. So, it is essential to seek advice from a qualified, authorised and registered professional. Note also that past performance is not a reliable indicator of the future performance of any investment.
All products have been selected by our editorial team; however, we may earn a commission on some products purchased through links in this article. Please note that any hyperlinks or references are provided for your convenience & information only. We are not responsible for the quality, accuracy, timelines, reliability or any other aspect of these products and services that you obtain from a site we have posted a link to. We also have no control over third party websites and accept no legal responsibility for any content, material or information contained or accessed in them. We make every effort to attribute the correct source of every image we use. If you think an attribution is incorrect or missing, please contact us at info@violasedit.com
You must be logged in to post a comment.