You saved some hard earned money and are thinking about how to invest it? Investing in dividend-paying stocks is one way of doing this and the 22 Dividends app is the tool that supports you on this endeavor.
A company emits shares in order to raise capital to grow its business. The shares are traded at a stock exchange where everybody can buy them to participate in the company’s success. Dividend payments are usually financed by a company’s profits. Many solid companies have a dividend culture and raise their dividends regularly. As dividend investor you are a business owner and profit from the generated cash flow.
Hint: This article is not an investment advice. Please consult a licensed investment advisor.
Why dividend investing?
There are countless ways to invest your money: real estate, the stock market, venture capital, or starting an own business. In each area you can further specialize yourself: investing in commercial real estate, fix-and-flip, investing in single family homes in the suburbs of big cities, etc. Each investment strategy has its own pros and cons.
Dividend investing is a long-term strategy where you gradually build-up a portfolio of high-quality stocks that generate a steady cash flow. By re-investing the received dividends the gains compound over time.
|Quick Success: Many US companies pay dividends multiple times per year. As soon as you bought your first dividend stock you are only few month away from your first dividend payment. Building-up the cash flow over time is “fun” and rewarding.||Taxes: Depending on where you live each dividend payment might be subject to taxes.|
|Cash Flow: The stocks you own generate a steady cash stream without you having to sell them. Especially, when you built-up your portfolio over a long period of time it would be a pity if you had to sell stocks in order to pay your bills.||Stock Picking: Usually, dividend investors pick individual stocks. Choosing the “right” companies requires you to invest some time to do the necessary research.|
|Less Stress: Share prices change almost every second. In general, the dividend payments of a company are much less volatile than the share price. This is a psychological advantage in hectic times.||Long Term: Dividend investing is not a get-rich-quick scheme. It takes years to build-up a good dividend portfolio.|
|Risk Reduction: If a company goes bankrupt nobody can take away your already received dividends. Each payment gets you a certain percentage of risk out of the investment.|
|Location-independent: Today, you can manage your dividend portfolio from every place on earth via internet. Depending on your broker you can buy shares at all mayor stock exchanges worldwide.|
Dividend investing has many great advantages. However, the disadvantages should be well considered. Am I willing to do the research on individual stocks? How strong do the taxes affect me?
Before you start with dividend investing you should think about your overall goal and how much money you want to deploy. It is recommended to invest small/medium amounts regularly over lump-sum investing. More details about the reason you find in the section about “cost averaging”.
Many investors distinguish their investments into three categories:
- Investment: Something that pays you to own it with the intention to hold it for a long time.
- Speculation: Speculators “bet” on a ricing or falling price of an asset in a short or medium time frame with the intention to sell it. They try to time the market.
- Insurance: Something that preserves value and let you sleep at night.
As dividend investors you should be able to answer following questions:
- What is my time frame? It takes time until dividend payments and dividend raises compound. Nothing is worse than being forced to sell your portfolio because your car broke down and has to be replaced.
- How much money am I able deploy every month? You reduce risk by distributing your investments over time. Think about how much money you can deploy each month. If you have some extra money at the end of the month you can make additional purchases.
- How much money do I need in my emergency fund? Make sure you have an emergency fund so that you don’t have to sell your stocks in bad times.
Price vs. Value
“Price is what you pay. Value is what you get.” This quote of Warren Buffet sounds trivial but it is hard to master. An indicator for dividend investors is the price/earnings ratio (P/E ratio). It tells the investor “how many years the company needs to earn its current market value”. The typical P/E ratio differs from business sector to business sector. The P/E ratio is only one indicator of many.
When to buy a stock?
How do you buy a stock at the cheapest price? You don’t. Except if you get lucky. For most people trying to time the market is a way to loose money. Dividend investors approach this problem by splitting their investments into several tranches. For example, if you made the decision to invest 2,500$ into a company you split the money into 5 purchases of 500$ each over 5 months. So, you get the average price in this period.
When to sell a stock?
Most dividend investors accumulate stocks over a long period for time and only sell them when the underlying business changes to the negative. However, one has to distinguish between temporary and fundamental problems. Temporary problems can often be used to accumulate more stocks at a lower price.
Types of Dividend Stocks
There are different types of dividend-paying stocks. Some companies pay a low initial dividend but grow it rapidly each year. Others pay a high initial dividend but only grow the dividend very slowly. It depends on your point in life and your general preferences what you buy. In the long run stocks with high dividend raises each year are preferable. A well-balanced dividend portfolio should have mixture of different types of stocks.
The beauty of dividend investing is the compounding effect. There is a number of companies that have a long history of yearly dividend increases over the last 10, 20, or more years. You buy a share once and benefit from the increases without doing anything. If you re-invest the dividends you will benefit from the compounding effect over the years.
One way of reducing risk is the already mentioned cost averaging effect where you distribute your purchases over a long period of time. Another important way to reduce risk is to diversify your portfolio by investing in companies from different sectors. Moreover, don’t overweight single positions because you think it is “a sure thing”. It is only a question of time when you get punished …speaking from experience.
The stock market is a place where you can learn a lot about your own personality. It is inevitable that you will be confronted with fear, greed, and irrational behavior of masses. In difficult times it is important that you trust the companies in your portfolio. If you just buy a hot stock a Youtuber recommended you will get doubts and make wrong decisions. Do your homework.