Investing

5 Reasons to Build a Dividend Stocks Portfolio

Dividend Stocks Put Money in Your Pocket

The most obvious reason why investors should invest in dividend paying stocks is the cash they return. When an investor buys a stock for appreciation, she is hoping that she can buy at, say $100 a share, and sell it at a higher price, say $200 a share, several years later. Although dividend investors also want appreciation, they are at least partially interested in the dividends the stock is paying.

Let’s say a retiree has a $500k portfolio of dividend paying stocks with an average yield of 3%.  These figures translate to $15k of dividends being paid out to our investor, money that goes into her pocket. That can be a nice complement to Social Security and pension payments she may be eligible for.

Dividend Stocks Are Less Volatile

Historically, dividend paying stocks have proven to be more resilient and less volatile during market downturn. The rationale is two-fold:  1) Investors who gravitate toward dividend stocks tend to be longer term holders who are less likely to sell at the first sign of market weakness; and 2) Dividend stocks’ cash payments make them more attractive to hold onto.  When there’s volatility in the market and portfolio managers want to rotate money into more security holdings, they often look to bonds and higher quality stocks that pay dividends as a safe haven to smooth out the ups and downs of their portfolios.

I personally own a mixture of dividend and growth stocks, and dividend and growth oriented funds and ETFs, so I’m by no means saying investors should avoid non-paying or low-dividend stocks. I’m just emphasizing dividend stocks and portfolios in this article to highlight their value and importance.

The following article explores how dividend stocks are less volatile.

http://www.fa-mag.com/userfiles/docs/whitepapers/Dreyfus-October-WP-Reasons-to-Consider-Dividend-Paying-Stocks.pdf

Dividend Stocks Can Be Long Term Winners

There’s no guarantee in life and conditions change, but those stocks that can sustain their earnings and increase dividends have proven to be long-term winners. Coca Cola, Pfizer, Philip Morris, and AT&T are just a few good examples. Some of these companies have been in business for over 100 years, have survived several world wars, the Cold War, the Great Depression, and the Global Financial Crisis.  And even better, as long as people continue to buy their products and services, they will survive many more crises and keep on paying their dividends.

Over a long period of time, a stock’s value moves in-line with its earnings growth. Companies that can grow their earnings over time and have an investor friendly approach will see their stocks increase dividends and value over time.

Dividends Can Be Reinvested

Many dividend stocks can be automatically re-invested. Instead of getting the dividends as a check mailed to you, you can have the dividends purchase more of the underlying stock. Many companies have free or low-cost dividend reinvestment plans (DRIPs) that administer this type of plan for you and investors can learn about them from those companies themselves. Charles Carlson has written books and articles on DRIPs for years and his website is a wealth of resource on this topic —  http://www.dripinvestor.com/index.asp

Scottstrade has a program that allows investors to automatically reinvest dividends as well, which may make it simpler for investors to participate in DRIPs — https://www.scottrade.com/investment-products/FRIP.html.

Growing Dividends Show Lasting Power

Earlier, I mentioned several long-term stock market winners like Coca Cola and Philip Morris that have been generous dividend payers over the years.

Additionally, a recent Morgan Stanley study shows that over the past 80 years, 40% of stocks’ total returns have come from dividends.

Dividend Returns of Stock Market

                                Source:  Morgan Stanley, Business Insider

Dividend Investing:  Putting It in Practice

For most investors, picking dividend paying stocks may be too time consuming or they pay not have the requisite skills and experience, but fret not. There are numerous off-the-rack products that meet their needs.

Index Dividend Funds and ETFs

  • Blackrock iShares Dividend ETF (DVY):  It’s comprised of 100 broad-cap US companies with 5-year records of paying dividends.
  • SPDR S&P Dividend ETF (SDY):  It tracks the S&P High Yield Dividend Aristocrats Index.
  • Blackrock iShares Cord High Dividend ETF (HDV): It’s made up of 75 high quality US companies whose stocks pay dividends and have been tracked for financial health.

Actively Managed Dividend Funds and ETFs

  • Vanguard Dividend Growth Fund (VGIDX):  It’s an actively managed fund that seeks to invest in companies growing their dividends.
  • Fidelity Equity Income Dividend Fund (FEQTX): It seems stocks with reasonable income that have a yield that exceeds the composite yield on the securities comprising the Standard & Poor’s 500 Index.

These are just a short list of dividend paying funds.  There are many many more to choose from.  Some good resources for dividend fund research include Morningstar.com and Kiplinger and Money magazines.

For those willing to roll up their sleeves and research individual dividend stocks, check out this video from Morningstar that shows how to pick dividend stocks:

 

Additional Resources:

http://www.investopedia.com/university/introduction-to-dividends/investing-in-dividend-stocks.asp

http://www.marketwatch.com/story/should-i-own-more-dividend-paying-stocks-when-i-retire-2014-01-10

 

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