You may be familiar with the concept of portfolio diversification, and you may also be familiar with the concept of dividend investing, but do you know how dividend investing can help you create a more diversified portfolio? When you invest in dividend stocks, you benefit twice from both the dividend payment as well as appreciation in the stock itself. How does this help you balance your portfolio as you head closer to retirement and after you have retired?
What’s a Dividend?
A dividend is a distribution of cash made directly to stockholders. Companies do this as a means of making their stock more attractive to investors as well as a means of getting rid of excess cash that the corporation may be holding. Dividends are often granted on a quarterly basis, but a dividend can be granted on a monthly, bi-annual or annual basis. While the dividend yield and the amount of each dividend are the two most important factors to look at when investing in a dividend stock, the frequency of the dividend can be important for compounding purposes.
What Are the Advantages of a Dividend Stock?
On average, a non-dividend stock will appreciate 7 percent each year. However, the annual average dividend is an additional 4 percent each year on top of that 7 percent capital growth, which means you can average 11 percent returns annually.
That extra 4 percent can then be reinvested back into buying more shares of the dividend stock, which enables you to take advantage of additional compounding. If you don’t want to reinvest your dividends back into the company, you can take a cash payment that can help pay bills or take care of other needs in retirement.
Companies that offer a dividend tend to be stable with a predictable cash flow. Otherwise, they wouldn’t be able to offer the dividend or wouldn’t offer the dividend on a regular basis. Companies such as Coke and Proctor and Gamble have offered dividends for the past 50 years.
How do You Choose a Dividend Stock?
Not all dividend stocks are created equal. The first thing that you want to look at is a company’s dividend yield, this is the percentage of the annual dividend compared to its current stock price. While you want the highest possible yield, higher yields can actually be a sign of an unstable company. In some cases, a business may offer a 15 or 20 percent yield to attract investors because its fundamentals don’t suggest it is doing well.
You should also look at how long a company has offered a dividend. There are instances when a company has offered a dividend and then revoked it later because it no longer had the cash to offer it. This can be problematic for investors who count on the regular income the dividends provide or are hoping to boost their savings through dividend reinvestment.
Those who are more conservative investors may want to look at Dividend Aristocrats, which are companies that have increased their dividend each year for the last 50 years or more. However, if an organization has offered a dividend for a year or more, there is a good chance that it will continue to do so. If it has offered a dividend for the last decade or longer, that is a good sign of stability.
Don’t Forget the Tax Advantages of Dividend Investing
If you receive a qualified dividend, it may be taxed at the same rate as other long-term capital gains. A dividend is qualified if it has been given to shareholders of an American corporation, a foreign company incorporated in a United States possession or any foreign company that otherwise enjoys United States tax treatment.
You must also hold that stock for at least 61 of 121 days starting from 60 days before the last dividend’s ex-dividend date. If you meet these requirements, you may not have to pay any capital gains tax on some or all of your dividends depending on your tax bracket.
You Don’t Necessarily Need to Invest In Stocks
There are many products available to those who want to diversify through dividend paying equities. If you don’t like individual stocks, you can buy mutual funds that allocate a portion of their holdings to divided stocks. You can also buy ETFs or index funds that come with high diversification, low fees and quality dividend payments.
Diversification is critical if you want to retire comfortably. It enables you to offset losses with gains elsewhere while also ensuring a return on your investment in the short-term, even if the underlying stock’s price stays flat or goes down during a temporary lull in the market.
Talk to your financial advisor to see if a dividend centered portfolio is right for you, and your retirement.
Thank you Accuplan Benefits Services for this guest submission.
14 thoughts on “Building a Dividend Centered Portfolio for Your Retirement”
Dividend growers are really awesome. Only problems that I have is that they are typically expensive so I will have to wait until they get cheaper! Bad news really help here 🙂
BeSmartRich recently posted…April 2016 Dividend income update: $599 (+$471, +368%)
Sometimes you have to pay up for quality names. This is very apparent in the consumer staples space where it seems that stocks in that sector are always expensive even when the market dips. Like you, I wouldn’t mind another blip in the market for some better buys. Thank you for commenting.
What do you mean by expensive? If you take the dividend champion list you can find at least 50 that have a P/E under 20 (just to start with).
Evan @ Building Income Investments recently posted…May 2016 Undervalued Dividend Growth Stock Screen
That’s true to an extent. Sometimes those low PE stocks are low for other reasons besides trading at a good value. Thanks!
I love me some dividend growth investments. Aside from index investing I think DGI is the simplest and most straight forward way for the majority of people to invest.
JC @ Passive-Income-Pursuit recently posted…Weekly Roundup – May 14, 2016
I couldn’t agree with you more. It’s really not as difficult as some might have you believe. Just takes some research, the ability to not get seduced by unusually high yield, diversity, patience and consistency for a long term successful path. As always, I appreciate your comment.
Gotta love watching dividends pile up month and month, giving you raises that your company may not otherwise give you. Not to mention, you get raises for not having to do any work!
That’s the beauty of being a dividend growth investor. I still wonder why more people have not subscribed to this investing methodology. It just works. We see this in real time as we read dividend income updates each month among our blogging peers. Thank you for sharing your thoughts.
I agree, you don’t have to necessary invest in stocks. In fact, my first investing experience ever was with Betterment.
In betterment, I constantly watched my portfolio dip and fluctuate (I don’t recommend watching your portfolio daily), but I was always SUPER excited whenever my Betterment Portfolio said I received $0.10 in dividends. I was like WTF. I get money just for owning a stock. After that, I was hooked!
Point being, just another example of not having to own individual stocks to enjoy the benefits of dividends.
Wallet Squirrel recently posted…Latest Stock Buys and Watch Lists
I think your experience is similar to many who receive their first dividend payment. It doesn’t matter the amount, rather just the realization that money was given to you simply for holding an equity position. I wish that light would have went off in my head when I received my first dividend but I was too young to understand what it meant getting that check in the mail. I was about 15 at the time and was happy just buying my first stock. Looking back, it would have been nice to have some guidance nudging me towards a dividend growth strategy but it was a different time and you could get a CD paying over 8% at the time risk free instead of 2% or 3% from an average dividend paying stock. Thank you for stopping by and commenting.
I love the idea of receiving dividends on a regular basis, a complete newbie here and still learning basics of investing, dividend investing definitely sounds like a solid strategy. I’m leaning toward having a hybrid solution: half (or some percentage) in index funds, and the other half in individual stocks (dividend paying or not, haven’t fully figured out this yet). What do you think of this approach?
Once you start receiving those dividends you’ll see how addictive it can be watching that passive income grow year over year. Be patient with your investments, stick to quality sustainable dividends and don’t chase high yield. There’s nothing wrong with investing in stocks and index funds. Investing is a very personal matter and you must invest based on your tolerance for risk. Personally, I have chosen the route of investing exclusively in dividend paying stocks and would not consider any index funds, ETFs, etc. Again, there is a place for stocks and funds in a portfolio, but not for me. Thank you for commenting.
Dividend investing is a great strategy. It’s sweet to get dividends few times per year.
However, it is important to buy the company’s shares at the right moment, you don’t want to overpay for any stock.
Rudy SMT recently posted…Couch Potato Investing – The Lazy Way To Wealth
For the most part I think almost all dividend investors have value in mind when making a purchase. From reading the various blogs it seems that a lot of factors go into a buy decision. But you are right, in general it’s bad practice to habitually overpay for a stock. Thank you for sharing your thoughts.