Choosing the best, most secure, and long-term beneficial way to invest is a challenge. While turning to individual stocks is an excellent solution, taking it a step further is even better.
As a small, beginner investor, you learn as you go on how to build a solid diversified portfolio. One of the best ways to invest is in dividend-paying companies.
These are profitable companies that have continuous growth and tend to raise their dividends throughout the years. You, as a shareholder, are awarded for buying and keeping your shares each year.
Depending on your long-term investment plan, you can either take the money from the dividends and treat yourself or reinvest it.
Dividend growth investing is an active investing strategy of acquiring and keeping shares from trustworthy companies with a history of paying stable and increasing dividends each year.
What Are Dividends
Dividends are a way for the company to give back some of the profit to the shareholders. When you buy shares, you become a part-owner of a company. So that company shares the profit made that year, month, or quarter with you via dividends.
Dividends are calculated as an amount per share; for example, one share has a $1 dividend. If you own 50 dividend-paying shares, you get $50 yearly in dividends.
Companies forecast the dividend payoff for the year, but they’re not obligated to pay the forecasted sum. In fact, they can cut or cancel the dividend for the year. But no reliable company would do that because shareholders would then opt to sell their shares, causing the company’s stock market value to fall.
This speaks volumes about how reliable dividend-paying shares are compared to other ordinary shares. Some of the most valuable companies have been selling dividend stock for more than 25 years, with their dividend continuously growing.
Dividends are paid at whatever interval the board of directors decides; the most common dividend payout intervals are yearly or quarterly. They are mostly paid in cash, but there are also stock dividends where each shareowner gets a certain number of shares as dividends.
Taking the cash from the dividends each year is tremendously tempting. You are free to use it in whatever way you decide, save it or splurge on whatever caught your eye. But it would be best if you looked at the bigger picture here.
Reinvesting the money you get from dividends in buying more stock can benefit you more long term. Simply put, more dividend-paying shares = more dividend payoff = more money each year.
As with everything, no one solution fits all situations. In some cases, reinvesting dividends is not the smartest choice. If the company you own shares in continues to thrive and dividends grow each year, that’s a reliable company.
But if the company is not as profitable or is struggling, it’s smarter to take the money and reinvest it somewhere else or send it towards savings.
How To Get Started On Dividend Growth Investing
The first step towards dividend growth investing is to do your research on dividend-paying companies. How they performed in the past and how much their dividend has grown will tell you about their profits and stability.
Dividend growth investing is a way of securing oneself a passive income, so it gained massive popularity among newbie investors and finance enthusiasts.
The second step is to understand that dividend growth investment focuses on reinvesting at all times. The strategy principle is to buy shares with each dividend payout even if it went significantly up in price this year.
Dividends depend on profit, so as long as the company is making a profit, you will receive your dividend, and it may grow, but this doesn’t fixate the share price in any way.
Optional Dividend Growth Investment Strategies
Depending on your long term plans, expectations, and what kind of investor you are, there are a couple of investment strategies you can opt for when it comes to dividend growth investment:
- Collecting shares from companies whose annual dividend growth covers at least the year’s inflation;
- Keeping shares for decades to benefit from deferred taxes and for more dividends to be paid to your family;
- Not relying on one currency – buying dividend-paying shares from around the world so you can receive dividends in different currencies;
- Diversifying your portfolio by buying shares from various industries and not relying on dividends from a single sector.
Why Choose Dividend Investing
Dividend-paying companies usually share only 20% to 70% of the profit with their investors and use the rest to reinvest in the company. This makes them more profitable the next year and serves as a guarantee for long term stability.
Let’s go into detail about why you should choose dividend growth investing over cashing out the dividend and ordinary shares.
- Example A: You own 50 dividend-paying shares you bought for $50 each.
Each year you receive a $10 per share dividend, making that $500. Using the dividend from this year, you can buy 10 more shares and own 60 dividend-paying shares the next year.
Let’s predict the dividend will grow 5% next year. So you have 60 shares with a $10.5 dividend, making that $630 in dividends.
If you took that $500 in cash the first year, you’d have $525 in dividends the following year and still only 50 shares.
- Example B: You own 50 ordinary shares you bought for $50 each
Let’s predict they’ll grow in value by about 5% in the following 10 years. After 10 years, you’ll have 50 shares with a $75 value each. For 10 years, you’ve received no money from those shares so far, and to capitalize on them now, you have to sell them. You’ll still gain profit, but to acquire more shares, you’ll have to invest money from other sources into buying more shares.
Of course, we’re speaking hypothetically, but it allows you to imagine your investment growth over the years if you keep reinvesting the dividends and buying dividend-paying shares instead of ordinary.
There’s a ranking of selected companies that are considered dividend aristocrats in the investment world. The first list was made in 1989 with only 26 companies on it, and in 2020 there are 66 dividend aristocrats.
These companies have increased their base dividends continuously for more than 25 consecutive years. Of course, this makes them the most favorable shares to own. What are some of the dividend aristocrats?
- Colgate-Palmolive, Johnson & Johnson, Procter & Gamble, and Coca-Cola all have 57 consecutive years of dividend growth;
- McDonalds, Clorox, and Walmart have 43 successive years straight growth;
- Caterpilar, Chubb, and Carrier Global Corp have 26 continuous years of dividend growth.
Imagine an investor bought a share from McDonald’s in 2007 for $53.
That share has so far accumulated $34.31 in dividends. That’s 64.9% of the share’s initial buying price. The share’s worth today is $174.03, so the investor has 64.9% of the invested money in dividends and an additional $121.03 in share price, for a total profit of $155.34.
Even if McDonald’s went bankrupt, the investor still has 64.9% of the invested value in dividends so that the loss won’t be as dramatic.
The Dividend Aristocrats are leaders in their industry, reliable companies, and significant investment opportunities that will secure you growing passive income for years to come.
The Pitfalls Of Dividend Growth Investing
Every investment comes with a risk; whether it’s low, moderate, or high, you can never be 100% in the safe. Dividend growth investing is relatively popular because who doesn’t want growing passive income every year?
This sounds too good to be accurate and can be lethal if you invest all your retirement savings in dividend paying shares. You can’t rely on high dividend growth to make you rich or secure comfortable retirement days.
Portfolio diversity is vital, so don’t dive in headfirst into dividend growth investing. Dividend growth investment contributes to faster-growing securities, and it might throw your portfolio out of balance and expose you to higher risk.
A company’s value is not represented by the dividend they payout but by its total profit numbers. With continuously growing dividends it can be hard to recognize when the shares price isn’t going well, and you need to pocket the dividends.
The dividend growth investment strategy is inexpensive, simple, and allows for fast-growing of your investments. Because dividend growth investment gained so much popularity, some companies use dividend traps to acquire more investors.
When choosing which dividend-paying shares to buy, compare the dividend payout in the same sector, and consult a specialist.
Investments and passive income are the ultimate top of the list of anyone’s financial goals but pay special attention to where your hard-earned money goes.
What are your thoughts on dividend growth investment? Do you own dividend-paying shares?