Basics of Investing in Dividend-Paying Stocks

High dividend stocks are considered one of the most traditional and easiest-to-understand options for investors seeking income. Although investing in the stock market involves more risk compared to investing in bonds, dividend-paying stocks offer moderate income and the potential for capital appreciation over the long term.

Benefits of Dividend-Paying Stocks

High dividend stocks tend to outperform the broader market over time. According to Ned Davis Research, dividend-paying stocks in the U.S. returned an average of 9.3% annually from January 31, 1972, to December 31, 2013, a significantly higher annual return than the average 2.3% for non-dividend-paying stocks. Additionally, over half of the total return of U.S. securities from 1930 until the end of 2010 was due to dividends, not price appreciation.

Dividend-paying stocks also perform better than the broader market during periods of stock price weakness. Because dividend-paying stocks are generally more conservative and have stronger cash flows than non-dividend-paying stocks, investors tend to gravitate towards dividend-paying stocks during times of crisis.

Dividends, by providing actual cash returns to shareholders, indicate the strength of the business behind the stock. Moreover, companies tend to use their resources more efficiently when they are less abundant – which is the case after paying dividends. Higher dividends mean more cash is in the hands of investors and less in the hands of a management team that may not make the right decisions.

What Does Yield Mean?

Naturally, there is more to dividend-focused investing than just seeking out the highest-yielding stocks. In some cases, a high dividend yield can be a warning sign that the stock price may be low for fundamental reasons. Investors also look for companies with strong fundamentals backing their dividends, such as strong earnings growth, healthy balance sheets, and attractive valuations.

On the other hand, it is not necessary to forgo growth to invest in dividend-paying stocks. Many companies with attractive yields are innovative global leaders – not the slow-growth companies that offer investors little possibility for long-term capital appreciation.

Bonds vs. Stocks

Investors trying to determine how to allocate their investments between stocks and bonds need to consider their broader investment goals.

If safety is the primary goal, the best way to proceed is to invest in more conservative instruments, such as government bonds or exchange-traded funds that invest in short-term bonds.

If income is the main consideration and the investor can tolerate some risk, high-yield bonds and emerging-market bonds are typically the best sectors to find the highest possible returns.

If capital appreciation is the priority and income is secondary – but still a point of consideration – dividend-paying stocks can play an important role.

Naturally, there is no need to invest in just one asset class. Often, it is necessary to combine these investments and others to generate the optimal balance between risk and potential total return and yield.

How to Invest in Dividend-Paying Stocks

Investors can build a portfolio that invests in high dividend stocks in three ways: buying individual stocks, investing in market-focused exchange-traded funds (ETFs), or using a broad range of market ETFs that focus on dividends. Among the most popular dividend-focused market ETFs are the iShares Select Dividend Index ETF (DVY), Vanguard Dividend Appreciation ETF (VIG), and SPDR S&P Dividend ETF (SDY). There are also many market ETFs that invest in high dividend stocks in specific sub-sectors of the market, such as small-cap stocks or emerging markets.

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Buying stocks or exchange-traded funds in the market through a broker, and mutual funds are usually available either from a broker or from the company through direct investment. Be sure to contact a financial advisor or use all available resources online to conduct comprehensive research before investing.

Source: https://www.thebalancemoney.com/the-basics-of-investing-in-dividend-paying-stocks-416832