By Daniel Baumgartner & Petra Peters
When a company earns profits, a portion of the profits may be given to shareholders as dividends. Dividends are usually distributed quarterly in the form of cash or reinvested in additional shares of stock. Businesses typically offer dividend payouts if they do not have business opportunities to reinvest their profits back into their business.
As with any investment vehicle, dividend stocks come with their own set of benefits and drawbacks. If you’re unfamiliar with them, educating yourself is the best way to determine if and how they fit into your portfolio. Let’s analyze the pros and cons of investing in dividend stocks.
Dividend Stocks for the Win
There are numerous benefits to investing in dividend stocks: you’ll receive quarterly dividend payouts from your shares in those companies; dividend stocks have consistently outperformed the index in the past few decades (as evidenced by data spanning 1986 to 2022); and dividends typically perform on a more consistent basis than non-dividend paying stocks. That same data set shows that dividend-paying stocks are also subject to less volatility than non-dividend-paying stocks.
Companies that pay dividends are often larger, strong businesses which can handle paying a portion of their profits directly to investors. These companies have a much harder time using “creative accounting” because dividends are paid in actual cash. Paying dividends is a clear sign to investors that the company is sitting on a solid foundation and has a healthy financial status.
Investors who choose to reinvest their dividend payouts are able to accrue shares without incurring commission costs. They also reap the long-term advantages of compounding. Reinvesting dividends has statistically shown to increase long-term returns.
Another benefit of dividends is the dividend earnings have the potential to counterbalance decreases in share prices. Dividend income’s growth potential can serve as a buffer against inflation, and buying dividend stocks provides recurring revenue.
The Downside of Dividend Stocks
Investing in dividend-paying stocks entails certain risks, such as the possibility of dividend payment discontinuation. Dividends are not guaranteed and require a long-term commitment. Steer clear of dividend stocks if you’re looking for a quick win.
There is not as much growth potential as non-dividend-paying stocks because those companies are regularly reinvesting their profits back into the company. Dividend payouts fluctuate with the market environment and are subject to instability because it’s up to the company’s discretion how much to pay out and whether or not to pay out. The company’s earnings can cause fluctuations in dividends.
The state of the economy, stock market, and the political landscape all have an impact on dividend stocks. The same risks inherent in index investing are present in dividend investing. Investments with a high growth potential also come with a higher loss potential. Dividend stocks are also historically impacted by interest rate changes.
Before investing in a dividend stock, it’s imperative to do your own due diligence on the overall financial health of the company. Determining the motivating factor for the company’s paying of dividends can tell you a lot. It may be that the company is having increased profits (good news) or it may be that the company is exhibiting stock price fragility (bad news).
Are Dividend Stocks Right for You?
Dividend stocks are better for investors who are in it for the long term—who are willing to take a patient stance with their investments and let the power of compounding work for them. They are for investors who are willing to do research and identify the best companies from which to buy shares. Partnering with an investment advisor can help you make a beeline to the dividend stocks that are well suited for your situation and goals.
Does it seem like we may be a good fit? Reach out to us directly at 212-355-1234 or firstname.lastname@example.org for the New York office (Petra) or 855-248-6630 or email@example.com for the New Jersey office (Daniel). You may also contact us here to schedule a meeting and we’ll get in touch with you soon!
Daniel Baumgartner is a founding partner of Terra Nova Asset Management LLC, a partner-owned investment advisory firm that manages individual portfolios for clients. Daniel has extensive experience in marketing, development of special U.S.-investment products, as well as customer acquisition and relationship management. His ultimate goal is to make a difference in his clients’ financial lives through honest investment advice. He strives to provide high-touch, personalized service and enjoys getting to know a client’s personality as it relates to their financial circumstances before crafting the right solutions. As money is a very personal subject, Daniel takes his responsibility as an advisor very seriously, forming long-term relationships with clients based on trust.
Daniel received his degree in finance and international business from New York University. Outside of the office, he is a hobby landscape, street photographer, and has a great interest in U.S. and European history (16th-19th centuries), believing it helps him answer the question “Why is something the way it is?”
Petra Peters is a founding partner and the Chief Executive Officer of Terra Nova Asset Management LLC, a partner-owned investment advisory firm that manages individual portfolios for clients. Petra has decades of experience in the banking industry, asset management, overseeing the administration of individual accounts, and designing and advising specialized funds tailored to the requirements of international private and institutional clients. With extensive knowledge of both Europe and the U.S., she’s able to provide advice and services beyond the typical investment advisor. Petra desires for her clients to live a financially care-free life so they can pursue their passions, and she values their trust and gratitude. Creating invaluable friendships formed over years of partnership, some clients even consider her part of their family.
Petra’s interests outside of work include classical music, history, travel, charities, motorcycling, and golf. She is also on the board of a German charity.