Investing in dividend stocks can help you reach your long-term financial goals, and make you a better overall investor.
Many people invest in dividend-paying stocks because they offer steady income, and the possibility of compounding returns.
Because many dividend-paying stocks are considered financially stable, the stock prices should steadily increase over time. If you stay patient and remain disciplined, dividend stock investing can provide stable income to fund your needs and desires.
What are Dividends?
When an investor buys a stock, they own a fraction of the company. Because of this relationship, the company’s profits are shared with the shareholder. And dividends are a popular way to give profits back to shareholders. Dividends are the portion of a company’s profits that they pay to investors.
Dividends are decided by the company’s board of directors. The size of the dividends depends upon the company’s performance. If the board of directors expects higher profits, they might declare higher dividends. Many companies increase their dividend every year… these companies are called the Dividend Aristocrats. They are a safe option for dividend investors.
1. Compound Your Wealth
Albert Einstein is noted for saying that compound interest is one of “the most powerful force in the universe.” And Warren Buffet called compound interest one of the three biggest factors contributing to his wealth.
It can be thought of as “interest on interest,” and it will make a sum of money grow at a faster rate than simple interest. Dividend reinvestment plans, also known as DRIPS, take advantage of compound interest. DRIPS allow investors to reinvest their cash dividends into shares of dividend-paying companies. In other words, investors can buy more shares with their dividend payments.
According to NerdWallet’s analysis of data, The S&P 500’s average return from 1928 through 2017 was about 7.6%. But, if all dividends had been reinvested, it would have been about 11.5%. That proves DRIPs increase your wealth over the long-term regardless of economic downturns. In most cases, DRIPs allow shareholders to get shares commission-free. And in some cases, the company will offer shares at a discount to the current share price.
Dividend reinvestment plans compound your returns, and allow you to seriously grow your wealth.
2. Beat Inflation
Inflation slowly erodes the purchasing power of your money. Most fixed income investments don’t account for inflation. Dividend stocks, on the other hand, do account for inflation. They tend to raise their dividends as inflation grows over the long-term. In fact, some companies increase their dividend every year.
There are 131 companies, the Dividend Aristocrats, that have raised their dividends every year for at least 25 years. There are another 205 stocks whose dividends have increased annually for at least 10 years (the Dividend Achievers) and 528 more companies who have raised their dividend every year for the last five years.
3. Outperform the Market
Berkshire Hathaway outperformed the S&P 500 in 2018, and it is not the first time. The company’s chairman, Warren Buffett, has earned a reputation for outperforming the market because of his intelligent stock selections. You can do the same. Instead of investing in an index fund do your own research. Chosen wisely, individual dividend stock selections post greater returns than the market.
Also, companies like the Dividend Aristocrats tend to be more stable, and less susceptible to the pitfalls of market volatility. If you choose the right companies you can get positive returns during bear markets.