Dividend investing is a hybrid strategy focused on generating income from your investments while also growing your wealth. Dividends are regular cash payments that a company sends to its investors. You can receive dividends as income, or you can instruct the company or your broker to reinvest your dividends in additional shares of stock.
Rarely has dividend investing been more essential.
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The Federal Reserve has kept short-term interest rates—known as the “federal funds rate”—near zero since the recession in 2008. That means the usual avenues for income investors—U.S. Treasuries, CDs, money-market accounts—are essentially worthless. Thus, dividend stocks have become the primary alternative for earning a steady stream of income from your investments.
That’s why more and more companies are jumping into the dividend pool. Roughly four-fifths of the companies in the S&P 500 now pay a dividend. Buying a stock that doesn’t pay a dividend can only reward you in one way: share price appreciation. Dividend investing, however, grows your wealth in three ways.
First, like with any stock, your portfolio increases as the price of the stock appreciates. Second, you will receive an income stream of dividend payments, which you can collect in cash or reinvest to further boost your holdings. Lastly, many companies increase their dividends over time, providing an income stream that often outpaces inflation, and greatly increasing the yield the longer you hold the investment. (Your yield is how much you earn in income every year as a percentage of your investment.)
Dividend investing has traditionally been regarded as a “safe” way to invest. However, with 80% of the S&P 500 now paying a dividend, dividend investing can now be combined with practically any other investing style, from buy-and-hold blue chip investing to high-potential small cap investing (yes, some small caps pay dividends!).
Whether you choose to invest in dividend-and-growth stocks like Apple (AAPL) or investments that are all about the income (like REITs), what all dividend stocks do, particularly those that have been paying and growing their dividends for years (e.g. “Dividend Aristocrats”, companies that have increased their dividend payments annually for at least 25 years), is provide a buffer against huge losses. Investors treat a stock’s dividend yield like a floor, because it makes it easier—and more worthwhile—to hold these stocks through hard times.
Dividends are also proof of a company’s validity—there’s an old Wall Street saying that “dividends don’t lie.” That’s because dividends are cold hard cash paid to investors, so only companies that are actually raking in the money can sustain dividends over time. There’s no better indicator of a tried and true business than a long dividend history.
So dividend investing is a way to minimize your risk, and protect your portfolio against huge losses. It’s a way to fortify yourself against market volatility and the wild share-price fluctuations it brings. And as long as the traditional income avenues remain essentially closed off by the Fed, dividend investing will continue to be the most sensible way to build your wealth.
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