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Dividend Stocks: What to Know

Dividend stocks get a lot of hype because in an ideal world the dividend is a way to have a return from the stock regardless of how the market or that stock specifically is performing. If a stock grows by 5% and the dividend is 3% then you have an 8% return. If a good […]

Dividend stocks get a lot of hype because in an ideal world the dividend is a way to have a return from the stock regardless of how the market or that stock specifically is performing.

If a stock grows by 5% and the dividend is 3% then you have an 8% return. If a good quality stock drops in price over a year, then you still receive the 3%, so that’s a way to have some return even when the stock itself isn’t doing well.

So what’s the issue?-People will buy into this idea but then can get caught up in hunting for the best dividends.

The well-established companies that pay dividends do it as a way to keep people invested in their stock over another stock that may have higher growth potential. This is fine, but you are likely giving up some growth that you could get from a non-dividend-paying stock.

The greater problem is when a company pays a high dividend as a way to compensate you for the additional risk you’re taking by holding their stock.

A bit of context so you know what to be aware of when making the choice to use dividend stocks over growth stocks.

Companies that pay dividends are typically known as value stocks. They are well established and more focused on maintaining what they have built vs focusing on growing massively. Since their focus isn’t on growth, they take a portion of their profits and return that to those that own their stock as a way to thank or incentivize them for holding their stock.

On the other hand, growth companies will take their profits and reinvest them back into the company so they can expand and grow. As the stock owner, your incentive for keeping the stock is the growth it offers vs. the dividend.

One thing to be aware of is if the dividend is unusually high, which I would start to raise awareness around 4-5% and definitely if it’s higher than that. This is a huge red flag that something’s up with the company. Often, they are compensating you for taking on a high amount of risk. If a stock pays a 6% dividend but drops in value by 30%, that dividend isn’t going to make you feel better about your loss.

Dividends are often portrayed as a guaranteed return, but that just isn’t the case due to the chance that the stock can drop in price and greatly offset the dividend received. A company can decide to stop or reduce its dividend if ish hits the fan and they’re in a pinch.

At the end of the day, does it really matter if your portfolio growth comes from a dividend or growth of the stock? let me know what you think below as we take a look at some real-life examples.

I looked up a few of the first stocks I recognized from a Motley Fool article listing dividend “aristocratic” stocks which are stocks that have consistently increased their dividend every year for over 25 years. The first one here is J&J which pays 2.4%. It’s the blue line and the black line is the S&P500 over the past 5 years. Next is 3M which pays 3.34% and again fell really short compared to the S&P and next is KO which pays 3.34%. One thing I find strange is how these companies have increased their dividend for 57 years and are in the 2-3% range still… seems really odd that that is even a selling point, but ok it does show that those stocks have been around for a while. 

Now, let’s look at a couple of high paying dividends…I found this article that I’ll link below listing 14 blue-chip stocks yielding 4% or more.

Going through the list, looking at the past 5 years of performance, overall most of the stocks look pretty risky since they move up and down a ton and several of them are in the red quite a bit. I placed my cursor around the date the article was written which was May 29th, 2019 just to give that point of reference. You may have to pause if you want to see that price point. You can also take note of the dividend if you look in the bottom right under the dates.

When you’re chasing dividends you may find yourself in this volatile situation which is why I don’t see dividends as much of a bonus.

Now, let’s look at some growth stocks over that same time frame. These did really well and they’re all companies you probably use on a very regular, if not daily basis. 

Now, if you don’t want to decide which stocks to buy, the S&P 500 did really well over this same time frame, with more of an upward trend than we see with many of the individual stocks so you could just buy the index fund and keep it simple for yourself if you find yourself overwhelmed with choosing stocks. 

Another consideration with dividends is that the dividend is taxable as income even if you reinvest it in unless it’s in an IRA, also you have to invest a lot of money for the dividend to really be noticeable.

One exception I see for using dividends is if you’re in retirement or have a large enough portfolio to pull income from, then creating a dividend strategy could be beneficial because you wouldn’t have to sell your investments in order to receive income from them. In this phase of life, you may be less concerned with overall growth and want to focus instead on generating income from your investments.

Alrighty, that is my perspective on dividend stocks be sure to subscribe if you’re new here and if you want some individualized help with your financial life check out my services in the link below, see you next week, bye!

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