When it comes to investing, there are many theories as to which strategy will make you the most money. While we could debate the merits of various investing strategies, today I am going to talk about why dividend investing is the best strategy for making money in the stock market.
While this strategy won’t make you rich overnight, and the reality is that no honest investing strategy will, dividend investing will provide a solid long term return to investors who stay the course.
Let’s get started and see why dividend investing is so powerful.
3 Simple Reasons Why Dividend Investing Is The Best Strategy
#1. Reinvested Dividends Boost Your Returns
When you reinvest a dividend back into your portfolio, you put the power of compounding into overdrive and boost your returns.
For example, let’s say you invested $1,000 into a stock that yields 3% annually. While you could take that $30 and use it for something else, here is how reinvesting it works. If you reinvest the $30, next year you will earn a 3% dividend on $1,030. This ends up being just shy of $31. Carry this process out long enough, and you have a substantially larger portfolio.
Here is a great example of how you could boost your returns to over 11% annually just by reinvesting dividends.
#2. Dividend Stocks Provide An Income Stream
Let’s say you are an older investor who isn’t primarily focused on earning a higher return by reinvesting your dividends. Maybe you are looking for an additional income stream. Well dividend investing has you covered here as well.
The current yield of the S&P 500 Index is 1.90%. This means if you have $100,000 invested in the market, you can expect roughly $1,900 in annual income from dividends. While this amount doesn’t sound significant, historically the yield of the S&P 500 Index is closer to 3%.
That yield will increase your income to $3,000 annually. So for investors looking for an income stream, dividend paying stocks are the way to go. You can earn more income on your money by taking on a little more risk. And a little later, I’ll show you how to build a portfolio that will yield you more than the current 1.90%.
#3. Dividend Stocks Tend To Be More Stable
Finally, what if you are an investor who is nervous about investing? You know you need to take some risk to grow your investments and afford retirement, but the idea of investing scares you a little bit. What are you to do?
Here is where investing in high quality dividend paying stocks comes into play again. Typically you would invest in blue chip stocks. These are companies that have been around for a long time and have a stable history of earnings, returns and dividends.
The benefit of going this route is that you will see smaller fluctuations in share price. But this doesn’t mean you can’t lose money. Blue chip stocks, like any stock, can lose value at any time. They just tend to not be as volatile.
Of course, by being more stable this also means they aren’t growing as quickly as smaller firms. This means an overall lower expected return, though one still higher than if you put your money into a savings account at your bank.
Building Your Dividend Portfolio
Now that you know the benefits of a dividend investing strategy, how do you go about building a solid dividend portfolio that meets your needs? Before you begin to build you portfolio, you need to ask yourself a few questions.
1) Am I investing for long term growth or am I looking for an income stream?
2) If looking for an income stream, how much income do I need?
For a long term investor looking for growth, you should be trying to create a portfolio that yields roughly 3% a year. This will allow for your reinvested dividends to compound nicely over time and not add unnecessary risk to your portfolio.
If you are looking for income, your yield will depend on how much money you can invest and how much money you need from dividends. Understand that you might not be able to earn enough money from dividends. For example, if you have $100,000 to invest and need $10,000 to live off of, you are going to have a difficult time building a portfolio with a 10% yield.
Additionally, if you are looking for an income stream, be sure to include fixed income in your portfolio. This mix will help to create stability in your portfolio should the market drop and still provide you with an income.
The bottom line is that you cannot get too greedy when it comes to dividends, regardless of what your investing goal is. I suggest a 3% yield because you can find solid companies that yield this amount and still keep risk at bay.
When you get greedy and try to go for too high of a yield you get burned. In most cases the stock price is beaten down because the company hit hard times. It is only a matter of time until they slash the dividend in order to survive financially. Now you have a stock that isn’t yielding what you need it to and a stock price that has plummeted in value.
Don’t go for the home run, be reasonable and invest wisely. Doing this will allow you to benefit from dividends and not lose your shirt in the process.
Final Thoughts
A dividend investing strategy is a solid strategy for all investors. You can earn a steady income stream, boost returns and keep risk low by following this plan. The key is that you do your research and find some high paying, quality dividend stocks and don’t get too greedy.
As with any investment, once you get greedy, you set yourself up for loss and pain. Be smart and build a solid dividend portfolio that will pay you many years into the future.
Written by Jon Dulin
