What Is Dividend Investing And How Does It Work?

Dividend investing

If you’re looking to get into investing or grow your existing portfolio, you might be curious about dividend investing. Dividend investing can be a great way to receive passive income on top of any money you earn from the growth of your stocks.

And do, in this article, I'll walk you through everything you need to know about dividend investing. This way you can decide if this growth strategy is right for you!

What is investing for dividends?

When you invest in stocks, you typically invest in growth or dividend stocks. Dividend stocks not only offer growth on investment, like traditional stocks, they also pay out dividends over time. As a result, you can earn regular payouts on your investments. Many also consider them a safer option than traditional stocks. To get clear, let's first discuss what dividends are.

What is a dividend?

Dividends are paid out to company shareholders regularly over a period of time. Dividends offer a distribution of a company’s profits or earnings, paid to all shareholders on behalf of the company. This offers shareholders a regular stream of income as a company grows and profits, on top of the growth your portfolio will experience.

There are generally two types of dividends that you should understand:

  • Regular dividends. This type of dividend offers regular payments (typically on a set schedule) to shareholders. Regular dividends are often paid quarterly.
  • Special dividends. In addition to regular dividends, companies might offer special dividends which you can think of as one-time payments. These are paid once during exceptionally profitable quarters.

Pros and cons of dividend investing

Investing in dividend stocks can offer a great, safe way to grow your portfolio. But dividend investing isn’t always for everyone. Here are a few pros and cons to consider when investing in dividends.

Pro: It offers regular distributions

One reason why dividend stocks are so compelling is that investors (shareholders) receive regular, quarterly disbursements. This is often considered a better way to grow your money than simply leaving it in a savings account (even a high-yield account). However, the dividend rate needs to make sense. For instance, investing in a company with a 3.5% dividend yield will result in earning more on your investment than you would with a savings account with a 1% APY (annual percentage yield).

Con: Only select industries offer dividends

If you’re looking to diversify your portfolio, dividend investing can help, but should not be the only strategy. That’s because the companies who offer dividends are typically utility, pharmaceutical, and telecom companies. Fast-growing technology startups, for instance, often do not offer dividends. You’ll need to turn to other investment opportunities if you’re looking to diversify beyond these industries or take advantage of new, rapidly growing companies.

Pro: It's a safe form of investing

Dividend investing is less volatile than other forms of investing. As a result, it can be a safer way to invest and grow your money. While dividend investments can grow slower than other stocks, they’re often protected. They are also less risky during times of economic uncertainty.

Con: Payments go down as profits dip

Unlike investing in a CD or high-yield savings account, your money and disbursements are not protected or guaranteed. When profits decrease, dividends are also likely to decrease. This means your disbursements can vary greatly depending on a company’s earnings.

Pro: Dividends often increase

Although dividends can certainly decrease as profits dip, historically companies tend to increase dividends more than increasing them. Companies are more likely to increase their dividends if they do not carry a lot of debt.

If you’re looking for an easy way to earn money, dividends might become your new best friend. However, you’ll still want to do some research before diving in. When searching for companies that offer dividends, you’ll want to review their growth reports and projections. You'll also want to review past dividends to narrow down your list.

Dividend investing strategies

Now you understand what dividends are and the benefits and drawbacks to investing in dividends. Next, I’ll help you understand a few key dividend investment strategies designed to help you maximize your portfolio.

1. High Dividend Yield Strategy

One of the first strategies when investing for dividends is the high dividend yield strategy. You’d apply this strategy to slow-growing companies with strong financial backing and lucrative cash flow. With this strategy, you’d be able to see regular and immediate dividend disbursements.

2. High Dividend Growth Rate Strategy

This next strategy is used for companies that currently have small dividend percentages, but are growing rapidly and projected to expand significantly. With this strategy, you can buy more dividends at a low price and enjoy long-term growth as the company expands and is able to pay larger dividends.

3. Follow the DRIP (Dividend Reinvestment Plan) method

The DRIP strategy essentially takes the dividend disbursements you would earn and reinvests them back into a financially secure company. This approach allows you to grow your investment in the company over time. This in turn increases your share and dividend disbursements.

Is dividend investing right for me?

If you’re looking to diversify your portfolio and receive regular payments on your investments, dividend investing is well worth exploring. Investing in a secure company can offer you larger and more secure disbursements. However, investing in a company projected to grow rapidly over a short period of time can boost your earnings even more. Lastly, consider reinvesting your disbursements if you want to safely and slowly grow your shares in a company over time.

What happens to dividends if the market crashes?

What happens to your dividends during times of market uncertainty or downturn depends on the types of dividends you’ve invested in. While some dividends can certainly decrease when the market crashes, others have been shown to withstand economic turmoil. High-yield dividend stocks, for instance, can be a sound purchase during a market slowdown, since the price of buying dividends decreases.

Typically, if the economy is performing poorly, the market has a higher potential to crash (but not always). When this happens, many dividends will decrease. Some companies may increase dividends in an effort to put an optimistic outlook on the company’s performance. This could either keep dividends strong or backfire, resulting in a future decrease.

However, not all companies see profit decreases or losses during times of economic turmoil. Investing in a secure company with steady growth (but not a large increase in profit from year to year) can be a safe way to protect your dividends.

The bottom line when it comes to dividend investing

It’s important to maintain a diverse portfolio when investing. Including dividends in your strategy is a generally safer way to increase your shares while receiving regular disbursements from profitable companies. Finding financially secure companies that pay dividends can be a less risky way to grow your portfolio over time.

While investing for dividends, it’s a good idea to work with a financial advisor if you need one. This can be especially helpful if you have any questions about a new investment or investment strategy.

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