Dividend investing is a popular investing strategy often chosen by investors who are attracted by the prospect of seeing any potential returns in the form of both stock appreciation and dividend income. This group of investors might include those nearing retirement or those who are simply looking to adopt a more conservative investment approach. Either way, there are several factors to consider when choosing this kind of investment strategy. Some dividend stocks tend to be less volatile, but as with all investments there are still risks to consider when selecting a stock to invest in. Here is a closer look at dividend investing and some things you might want to consider to help you make the right decision for your portfolio. 

What is a Dividend Stock?

A company offering dividends on its stock agrees to pay shareholders a regular portion of its earnings from its operations in the form of dividends. These scheduled payouts are an incentive for owning the company’s stock and an excellent way for shareholders to generate income. Not all companies pay dividends to shareholders, so if dividend investing is a strategy you wish to pursue it is, as always, essential to research all investments before adding them to your portfolio.

Why do companies pay dividends?

Companies offer dividends to attract long-term investors by returning what is often a share of profits to them. Because these companies are often more mature and established, they can pay out dividends after covering their expenses and reinvesting funds into the company. In some cases, these established companies may see slower share-price growth and therefore be less attractive to investors without the incentive of a dividend payment, however, those same characteristics may well be exactly what enables such a company to be able to pay a dividend at all.

 How do I receive a dividend?

To get started, you must first identify and purchase a stock that from your research you know distributes dividend payments to its shareholders.

To be eligible to receive the dividend payment, shareholders must own the stock before what is known as the ex-dividend date. This is simply the cut-off point for the upcoming dividend payment. Assuming you meet this criteria and are subsequently classed as a shareholder of record, you can expect to receive the dividend on the published payment date, which is typically a few weeks later.

Some investors may choose to buy a shares before the ex-dividend date before immediately liquidating or selling the stock purely with intention of securing their eligibility  to receive the dividend payment without holding the stock longer term. This is considered a legitimate practice however, if you plan on using this strategy it is advisable to check with your broker to determine clearing policies and any stipulations around holding time.

Most dividends are paid to shareholders quarterly, annually or twice-yearly, however some stocks offer the opportunity to receive monthly dividends also. An example of a monthly dividend paying stock is Realty Income Corp (O), which currently has a dividend yield of nearly 5%. 

Some companies may also elect to offer shareholders one-off distributions called special dividends in addition to the regular dividend payout schedule. These may come as the result of the sale of a part of the business or perhaps when performance has far exceed expectations and the company wishes to reward shareholder loyalty. Special dividends are another great incentive for dividend investors to own a stock but shouldn’t be relied upon to inform your investing decision due to the fact they are not guaranteed. 

Why Dividend Investing Can Be a Great Strategy
Before choosing an investment strategy, you must consider your risk tolerance for potential losses as well as your investment goals. To determine risk tolerance it may help to determine the length of time you want to hold your investments for, perhaps based on when you expect to start making withdrawals. Typically, investors with a longer time horizon are better positioned to take more considerable risks because they have the time to recover from any adverse shifts in value, but defining risk tolerance is always a personal and individual decision. Generally, risky investments tend to have a higher potential for profits, which can be in the form of share price increases and/or an increase in dividend income.

How to Pick Good Dividend Stocks

One of the pieces of information you should review to determine whether a dividend stock is the right addition to your portfolio is he dividend yield, which is a relatively simple calculation in which the yearly payout is divided by the current price of the share to tell you how much you might epxect to receive.

For example, if 1 share of company XYZ’s stock is currently priced at $100 and it pays out an annual dividend yield of $4 per share then company XYZ has a dividend yield of 4%

$4 / $100 = 0.04 or 4%

Most investors would consider a healthy dividend yield to be between 2% and 6%. Anything above this might be considered to be on the high end of the spectrum and, if so, you should consider any investment very carefully. For example, you might wish to conduct a benchmarking exercise by researching the average dividend yield for the industry or sector which would give you an indication as to whether the stock you are considering has a sustainable yield. As the old saying goes, If it seems too good to be true, it likely is.

An unjustifiably high dividend yield might be used to attract unwitting investors into purchasing shares of a stock whose overall share price is falling. This is sometimes referred to as the dividend or value trap and means that while the dividend may seem attractive, all in all you may still in fact be losing money. Even over the longer term a high dividend payout is not worth it if your initial investment experiences a significant decline. 

Dividend History:  In addition to the dividend yield, you should consider a company’s dividend history. Key factors to consider include the consistency of the dividend payout, whether the company has increased the dividend over time and how often and whether the company has ever decreased or suspended its dividend at any point in its history and the reason why this happened. If a decreased dividend was the result of poor performance or siginificant debt this may be a red flag but if it was the result of a industry-wide issues like supply chain interruptions or a global economic event like a pandemic, it may not be so much of a concern as these things don’t necessarily suggest poor management practices.

Companies with super stable dividends belong to an elite group called ‘dividend aristocrats’, which are widely considered by investors to be among the best dividend stocks. Dividend aristocrats are companies that have consistently raised dividends for at least 25 consecutive years. In general, if a reliable dividend payout is essential to your strategy, choosing a dividend stock that has been paying a dividend consistently for a long enough time period will reduce (though not eliminate) the risk of a suspended or decreased dividend.

In addition to dividend research, it is important to analyze the company’s overall financial health. While the stability of the dividend is a critical aspect of dividend investing, a successful portfolio also depends on stock appreciation and therefore at least some growth within its industry.

Dividend ETFs

If you are interested in the idea of dividend investing but researching a plethora of individual dividend stocks is not something you have the interest in or time for, you may want to take a look at dividend ETFs An ETF, or Exchange Traded Fund, is a bundle of securities that trades on an exchange like a stock.

Dividend ETFs are a great way to add diversity to your portfolio while earning income from dividends. ETFs allow investors to invest in specific industries, regions, or investment types while avoiding the risks associated with investing in a single stock. 

These funds are often passively managed and trade in real-time on an exchange. They usually have lower expense ratios due to the fact they are passively managed as opposed to being constantly maintained by a fund manager. In short, dividend ETFs are an inexpensive way to add diversity and income to your portfolio in a specific area. 

While many ETFs offer dividends, several ETFs focus primarily on dividend yield by adding high yield dividend stocks as fund holdings. Some examples include the Vanguard Dividend Appreciation ETF (VIG), iShares Core Dividend Growth ETF (DGRO), and the SDY SPDR S&P Dividend ETF (SDY) ETFs. 

When choosing a dividend ETF, investors should review an ETF’s performance, expense ratio, dividend yield, and holdings.

Should I Enroll in a Dividend Reinvestment Plan (DRIP)?

A dividend reinvestment plan, or DRIP, allows investors to automatically purchase additional shares of a stock when the dividend is received. This practice allows dividend investors to build wealth over time by purchasing additional shares of the stock on a largely hands-off basis. This enables investors to benefit from the magic of compounding and what’s more, most brokers allow clients to easily add this feature at no cost. 

You can grow your total investment over time by opting for a DRIP plan, which often results in a higher return than taking the dividend in cash. However, investors should think about their needs and strategy before enrolling. 

For example, if your dividend strategy is to generate immediate or ongoing income, it may suit you better to take the dividends and not reinvest them.

Is Dividend Investing Worth It?
Dividend investing can be an excellent strategy for investors seeking risk-averse long-term growth or passive income. However, a dividend strategy may not be the right move for you if you are seeking high returns from stock appreciation. To determine if dividend investing is the right strategy for you, consider your current needs and long-term goals. 

Before starting or adding to a portfolio, you should always consider your risk appetite, goals, and plan.