Most people invest in order to build wealth, but find out quickly that there are many different strategies that can be employed to this end. Dividend investing is one of these, and many argue that while different trends and even sectors come and go, dividends have stood the test of time.

This guide will take a detailed look at the style known as dividend investing, breaking down what dividends are, how to harness them in order to grow your wealth, and comparing dividend investing with other styles so you can find what fits you best.

What are Dividends?

To get to the bottom of what dividend investing really is, we need to get back to basics. Stocks are often compared to building blocks of a company, but what they actually represent is ownership. In the early days, the founder of the company sells off some stock privately to investors, and then as the company grows, it sells stock to the public to raise even more money.

These seed investment and IPO phases represent the time when a given company is attempting to grow. The ultimate goal of a company is to make profits, but they also need to find the sweet spot in terms of size, market share and revenue—if you were going to make 10% profits year-on-year, would you rather do so as a mom n’ pop or a multi-billion dollar corporation?

Outside of selling shares to raise money as described above, most companies grow by reinvesting their profits. All of that cash goes into new infrastructure, more staff, more facilities, R&D, and innovation. As a side-note, this is what growth investing is all about—buying shares of small companies and watching them grow into much bigger ones.

Once a company decides that it has reached maturity and won’t gain any benefit from reinvesting or using their cash elsewhere at the moment, they can decide to pay dividends. Simply put, the company allocates a portion of its profits to be paid directly to shareholders.

Dividends can be paid out in different ways, but many companies do so on a regular schedule, whether that’s quarterly, semi-annually, or annually. It’s a way to reward shareholders and provide them with a steady income, and thereby attract even more investors.

What is Dividend Investing?

Now that we’ve established what dividends are, it becomes clear that dividend investing is a style of investing that focuses on companies that have a track record, or the likelihood, of paying consistent dividends.

For many people, this can become a matter of cash flow generation or passive income. Each share of a company that pays quarterly dividends becomes a near-guarantee of a paycheck every three months. If you have a significant amount of shares, or have managed to build a sizable portfolio, you may be able to live on dividends and give up that day job!

A company that pays regular dividends is also likely to be a market leader and enjoy a significant amount of stability. You might also expect a certain amount of capital appreciation alongside the dividends—just because a company is mature doesn’t mean it can’t corner even more of the market or expand into new ones over the long term.

The flip side of regarding dividends as a source of passive income is the potential for compounding. Often referred to as the 8th wonder of the world, compound interest is an unquestionably powerful tool and one that is very applicable to dividends via dividend reinvestment.

What this means is that instead of banking or spending the cash you receive as dividends, you use it to buy more stock of the same (or another) dividend paying company. Then, when the next payout comes, you’ll get more dividends since you own more shares—and this virtuous circle grows with each dividend payment if you’re able to keep reinvesting.

Dividend Investing vs. Growth Investing

The investing style most often in opposition to dividend investing is growth investing. As mentioned, growth investing focuses on companies that are hyper-focused on growth, reinvesting profits back into the business to fund expansion, research, innovation, and other areas that can boost both top and bottom line.

This then leads to capital appreciation, with the strides made by the company over time being reflected in their stock price increasing. The growth investing style is what most investors focus on, and it could be suggested that its potential for wealth gain is higher. That said, there’s no guarantee that the company succeeds, so there are risks to growth investing as well.

If you’re looking to decide between the two styles or work out whether dividend investing is really for you, here’s a summary of its pros and cons.

Benefits of Dividend Investing

  • Consistent income: Many companies that pay out a dividend do so on a relatively consistent basis, and are often unlikely to deviate since it would be taken negatively by shareholders and the financial media alike. This makes dividend investing a relatively predictable style, which in the volatile world of finance is a very good thing.
  • Stability: There’s no such thing as a perfectly safe or foolproof investment, but for a company to pay dividends, especially on a regular basis, they have to be operating from a position of significant strength. Dividend-paying firms tend to be stable and can often weather even the worst of market downturns without significant loss of share value. Some can even continue to pay dividends at the same rate through the worst bear markets.
  • Compound interest: If you don’t need the cash from dividends elsewhere, reinvestment is an extremely powerful tool and can lead to significant growth of your wealth at an ever-accelerating rate. You could consider it a far safer way to increase wealth than growth investing since dividend stocks are easier to pick.
  • Inflation hedging: Inflation is a buzz-word again after a decade of zero interest rates, and dividends can help to counter it at a personal level since many companies adjust their dividends alongside rising costs.
  • Steady appreciation: Even though you aren’t expecting exponential growth in the value of your stocks themselves, there’s an expectation that there will be some growth over a longer horizon. As such, you’re benefiting both from a safe, appreciating stock as well as the dividend payouts.

Drawbacks of Dividend Investing

  • Lower growth potential: Simply put, you can’t expect a dividend-paying company to grow fast because the money paid to shareholders could have been put toward growth instead. Dividends take away from growth potential, but most companies do find a balance between the two lest they get left behind by growing competitors.
  • Downturn risk: A dividend-paying company is expected to be profitable and stable, which means that its share price is rarely at a discount. An unexpected collapse, PR disaster, or other event could see the company cease to pay dividends and stop being profitable—which would mean a dramatic loss in share value.

How to Start Dividend Investing

If you’re interested in the potential and possibilities presented by dividing investing, the next move is to figure out how to get started. Luckily, we’ve broken things down for you into a quick checklist!

#1. Decide on an Investing Strategy

As we’ve already mentioned, dividend investing can be utilized in several ways, and it fits a certain risk tolerance. If you’ve got an appetite for higher risk, dividend investing may be boring, and it probably won’t give you the same rush as seeing your stock picks heavily in the green.

Even if dividend investing does check all the boxes, you still need to decide if you need the dividends as an income or would like to harness the power of compounding and reinvest them.

#2. Do Your Own Research

There are plenty of resources out there for a primer on which stocks would work best, but don’t fall for the hype—influencer (or Youtuber, or podcaster, or TV host) is often just a synonym for “paid shill”. Even if you think you’re getting good advice, make sure to do your own due diligence and check out the financials and history of stocks yourself.

That way, you can be sure that you’re making your own decisions and not being led astray. Times also do change, and you should be able to get a feel for a company’s consistency and likelihood of dividends continuing into the future with a little research.

#3. Pick Dividend Stocks or ETFs

If you’re looking to add an element of diversification to your dividend portfolio, you could consider dividend ETFs. While you don’t own the actual company shares, ETFs do pay out dividends, so they can be a decent option for you as long as you’re aware of the risks around ETFs. Check out our guide on ETFs for more!

If you decide that ETFs aren’t really your speed, you could just pick your own portfolio of dividend stocks or talk to a financial advisor about your goals. Dividend stocks are significantly easier to pick than growth or value stocks, after all, so it may simply be a matter of research for you.

Related: What are ETFs?

#4. Sign up with a Broker

Whichever investing strategy you’re going for, you’ll need a trading venue or platform to put it into action. Once you’ve figured out what dividend stocks or ETFs you want to buy, you can narrow down the list of potential brokers by which ones offer access to the lot. If in doubt, take a peek at our list of top free trading apps in 2023!

#5. Buy Dividend Stocks or ETFs

Once you’re signed up and confirmed with your broker or trading app, it’s time to take the plunge! It might be worth having a look at the stock’s price movement compared to the record date (the date on which you need to hold the share to be counted for a dividend). There’s an outside chance that you might spy a pattern of when the stock becomes cheapest, although dividends are generally priced in.

#6. Reinvest Dividends

If you want to benefit from compounding and grow your portfolio that way, you’ll need to consider your approach carefully. Many trading platforms have an option to allow you to reinvest automatically, so that’s one way to go. Alternately, you may want to collect the dividends first and then reinvest manually across your portfolio per your own judgment. Before you choose, remember to check on how taxation works with regard to dividends in your jurisdiction.

#7. Monitor and Adjust Portfolio

As safe and passive as the dividend investing style is, you may run into trouble if you elect to “set and forget”. It’s worth keeping an eye on your stock portfolio and how the companies in it are doing—if there are storm clouds on the horizon, you may have to liquidate a stock and replace it with another.

Other Investing Styles

If at this point you think dividend investing or growth investing aren’t really for you, here’s a quick look at a few alternative investing styles that might suit you better:

#1. Value Investing

Value investing is a timeless trading style brought sharply to the fore by the market events of January 2021 and value investor Keith Gill. It relies on identifying stocks that are being undervalued by the market and buying them at a sharp discount. This style is often suited to research-focused investors and analysts who usually look at metrics such as price-to-earnings and price-to-book ratios.

#2. Income Investing

Income investing offers similar benefits to dividend investing because, as the name suggests, it is a style focused on generating income. The main goal is to gain a consistent stream of income through instruments such as bonds, real estate investment trusts (REITs), fixed-income securities, rent, interest payments, and dividends. While dividend investing can be classed as an income investing strategy, income investing tends to feature a diversified portfolio of assets rather than just dividend stocks.

#3. Index Fund Investing

Focused on overall market growth and index performance for diversification and risk reduction, index fund investing lets long-term investors keep up with the market. However, there are more indices than just the S&P 500, and it’s possible to find dividend-focused index funds which track indices made up of dividend-paying stocks.

You might also find joy in sector-specific investing or quantitative investing, among a myriad other strategies, but most of these can be boiled down to elements of growth, value, or income investing with different tactics and approaches.

Key Takeaways

Dividend investing is a common trading style that offers the benefits of regular income and long-term growth with the additional potential of compounding. If you can identify companies that have a consistent record of and positive attitude toward regular dividend payouts, you can take advantage of this strategy.

Growth investing is always pitted against dividend investing since the two are often at loggerheads, the act of paying dividends meaning that the company has less to reinvest in growth. This means that growth investing is often more lucrative, but dividend investing can be considered safer since firms that pay dividends tend to be more mature and stable.

👉 If you’re interested in learning more about dividend investing or fancy discussing your top dividend picks, head on over to our trading page.

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