Growth or Income? Dividend Investing Is the Best of Both Worlds

Dividend Investing, Real Estate Investment Trusts (REITs), Retirement
dividend investing: old man and woman reading a newspaper outside

Those nearing retirement have heard talk about having to retire later in order to avoid outliving their savings.

But retirement should be achievable for everyone. So the solution is finding a new investing strategy. A new approach that provides cash flow, reliable growth, and a chance to secure the retirement you always thought you’d have. 

That approach is dividend investing.

In this article, you’ll learn why dividend investing is attractive for those planning for retirement, how it can generate passive income, and some ideas for getting started.

Why Dividend Investing Is an Attractive Option for Retirees

When you first begin saving, you’re likely to open an IRA or establish a 401(k) plan through your employer. But then you need to decide which vehicles you’re going to invest in.

Advice for investors on the younger side is usually to lean heavily on growth stocks. Growth stocks generally come with more return — and more risk. The thought is they’ll appreciate over time. 

Then, as you approach retirement, you’re often advised to transition over to fixed-income  vehicles because of their lower risk profile and steady production of income. But as of March 2021, yield on income investments is quite low. For example, the yield on a 10-year Treasury bill is just 1.63%. 

Dividend investing, however, offers the perfect mix of growth and income benefits. With a portfolio of dividend stocks, you can enjoy immediate income from dividend payments as well as longer-term share price appreciation over time.

In retirement, having a steady cash flow is critical. And if you can maintain your portfolio without having to sell your investments, all the better. That way, you don’t risk out of investments.

Dividend investing provides this type of structure.

Consider this analogy: Imagine you own an apple orchard. You have neatly aligned rows of apple trees. When it’s time to harvest, do you cut down the trees? Of course not! You pick the apples and let the trees continue to produce fruit for the future. Dividend investing operates in the same way.

With dividend investing, you can live off of the dividend payouts and without having to sell your stock to earn a return. This is especially important during times of crisis — e.g., market downturns or a deadly economy-crushing pandemic. 

When you’re a dividend investor, your principal investment remains untouched and has the potential to continue growing for the future.

Use Dividend Investing To Generate Passive Income

dividend investing: blackboard with Passive Income written on it

Passive income: It’s like the holy grail of financial freedom. And dividend income is passive income.

Investing in a dividend stock is essentially like “buying” future income.

As a dividend investor, you receive a check in the mail — or in today’s world, probably a deposit in your brokerage account — on a monthly or quarterly basis. You’re earning dividend income simply because you own shares of a company. And when you opt for dividend reinvestment, you purchase more shares of stock with your dividend payment, resulting in even more dividend income going forward. This is the power of compounding.

By focusing on this consistently increasing passive stream of income, you are more likely to have a more balanced perspective when it comes to market volatility. When the metric you use to measure your portfolio’s success is your monthly income instead of the stock price, you can ride the ups and downs of the market with more patience and fortitude.

Stock price is down? No problem. You know that you’re still earning income. And if you’re reinvesting your dividend income, a lower stock price means you’re actually buying more shares of stock — and getting future income at a lower price, to boot. 

How To Get Started With Dividend Investing

man walking alone in the street

Companies that pay dividends tend to be financially healthy companies. After all, they are willingly sharing profits with shareholders. Plus, to pay dividends, a company must have a solid cash flow and, therefore, tend to be very scrupulous when it comes to acquisitions or other growth opportunities. Let’s look at where to find dividend opportunities and how to evaluate them.

Dividend Aristocrats

Any company that outperforms the S&P 500 index is going to get your attention. And there are a group of dividend-paying companies that do just that.

These stocks are called the Dividend Aristocrats.

So, how does a company join this elite group? Well, to qualify, a company must first be in the S&P 500 and their market valuation must be at least $3 billion. The company must also have paid and increased its dividend for 25 consecutive years.

Tall order, right? These strict guidelines explain why fewer than 10% of the companies in the S&P 500 index qualify. 

There is another interesting quality of Dividend Aristocrats. Not only have they proven to generate steadily increasing levels of passive income, but the stock price of these companies also appreciate in value at an impressive pace.

So, if at some point this stock needed to be sold, you could make a significant capital gain.

Because Dividend Aristocrats have proven over time that they offer some of the most reliable dividend payments in the market, companies that qualify are very attractive for anyone looking to build an investment strategy that will provide sustainable cash flow during retirement.

The Dividend Aristocrats typically provide high yields and above-average dividend growth. However, when it comes to investing, a “sure thing” just doesn’t exist. So you must always perform your own due diligence when buying individual dividend stocks.

Other Types of Dividend Investing Opportunities

Dividend Aristocrats aren’t the only option for getting your start with dividend investing.

There are a variety of dividend-paying entities throughout many industries. Banks, energy companies, utilities, and real estate investment trusts (REITs) are all areas where you can often find high dividend yields.

Buying individual dividend stocks isn’t your only option if you’re interested in becoming a dividend investor. Other options include dividend growth mutual funds or exchange-traded funds (ETFs).

How To Evaluate Dividend Stocks

Below are a few markers to look for when evaluating dividend stocks.

  • Dividend yield: This is the ratio of dividend payout per share to stock price per share.The best dividend stocks yield 4% or more. 
  • Dividend growth over time: Dividends growing over time is, of course, a good sign. Look for at least 10 years of consecutive growth. You can also look for average annual growth, which shows promise when it’s between 5% and 10%.
  • Earnings growth: This should keep pace or outpace dividend growth rates. A company with strong earnings growth is likely to continue paying dividends at its current rate — or potentially even increase the dividend payout over time.
  • Dividend payout ratio: This is the total amount of dividends paid to shareholders in relation to the total net income of the company. The payout ratio provides insight about the company’s maturity. An ideal payout ratio is typically between 30% and 55%. Ratios higher than that are difficult for companies to maintain over the long term.

Pave Your Road To Retirement With Dividend Investing

Dividend investing provides an opportunity to establish steady income and cash flow for retirement. And no matter what happens to the stock price, you can count on your dividend income to grow significantly because of the power of compounding. 

Now that you’ve taken the first step toward educating yourself about dividend investing, you’re that much closer to building a reliable income stream for retirement. To maintain that momentum and learn about three dividend stocks you should buy and hold forever, subscribe to Investors Alley “Dividend Hunter” newsletter.

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