What’s better than a stock that soars after you’ve bought it? One that pays you dividends, too.
Dividends are periodic payouts of earnings that some companies give to shareholders. Typically, doing so says to the world, “We’re doing great! Take our money! We’ve got plenty!”
As investors, we appreciate the steady payments. In return, the thinking goes, we’re more likely to hold onto our shares, which can help keep the company’s stock price up.
Well, despite the comfort a little extra cash in our pockets provides, dividend-paying stocks are still stocks, which come with some risks.
“People hear ‘dividend,’ and they think ‘safety,’ but it’s just not true,” says Taylor Schulte, Certified Financial Planner and CEO of Define Financial in San Diego. “Dividend stocks can drop in price just as much non-dividend-paying stocks.”
Some sectors, such as telecoms and utilities, are more likely to offer higher payouts, than others, so focusing solely on dividend payers can stifle diversification. Plus, applying just one strategy to your investing plan—in this case, just targeting dividend-paying stocks—is also limiting.
What’s more, some dividend payers could suffer as interest rates continue to rise, and debt becomes more expensive. According to a recent Standard & Poor’s report on dividend strategies: “The previous low-interest-rate environment paved the way for many of these businesses to load up on debt to expand their operations, while continuing to pay high dividends. As a result, many of these companies may come under pressure when rates rise.”
It’s not a bad idea. After all, cash in hand makes a lot of sense. Schulte just cautions against making that the center of your investing strategy.
Instead, consider making dividend investing one part of a bigger plan. And make sure that whatever stocks or funds you buy are a good fit for your portfolio overall, in terms of cost and overall diversification.
To that end, Schult recommends low-cost mutual funds or ETFs for simplicity and diversification. “Choosing to buy individual dividend-paying stocks instead offers a higher potential return, but you are assuming a lot more risk,” he says. “Unless you are an expert at trading stocks, a low-cost fund or ETF is likely the better solution.”