When it comes to investing in stocks, there are certain stocks which pay dividends back to shareholders. Here are 5 reasons why you should invest in dividend stocks versus stocks which do not have dividends.
1. Real Cash Returns
As the saying goes, a bird in hand is worth two in the bush, When stocks appreciate in value, what you get is paper gain, which means that you can only lock in the returns if you sell it. However, when a stock gives you a cash dividend, it is a realized return as the money goes straight into your pocket. It is better to earn the income from dividend yield first than to just simply wait for the price to go up.
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2. Long Term Income
Buying a stock for its Dividend Payments also ensures a long term stream of income. Since you do not have to sell the Stock, the money making engine continues to make money for you as long as you stay invested. This of course is the most important, as it allows you to build Passive Income. Through compounding as explained below, we can also increase this income stream dramatically over time. Dividends can also increase over time as the company grows its business.
3. Compounding Returns For Faster Growth
When you receive the Dividends in cash, you have the choice to either keep the cash or reinvest it. Certain companies also allow you to enrol into DRIPS, better known as Dividend Reinvestment Plans. DRIPS allow the Company to directly convert your dividends into more stocks normally at a discount to the current market price with no fees. It’s one of the best ways to maximize returns in a strong Company. Let’s say you buy a $10,000 worth of Stocks which pay out 5% dividend, you will receive $500 in dividends this year. If you reinvested the $500, it makes another 5% which is $25, bringing dividends this year to $525. You reinvest the $525, which brings total dividends to $551.25. Simply put, you make more dividends on the dividends received, compounding and growing your value exponentially. Assuming all factors remaining constant, by year 20, you would be making about $1,200 in dividends a year versus $500 if you haven’t reinvested. That’s a pretty good return considering that you only invested $10,000 at the start and nothing else after!
4. True Measure of Performance
The standard measures of performance such as revenue and earnings can be manipulated and even faked. In the recent accounting scandals, many listed Chinese firms were thought to be overstating profits and even their cash balance! Dividends however, are real cash, either they have it or they don’t. Companies which are not doing well will not be able to pay out good dividends year after year if they were not making good money. They would either have to pay Dividends out of dwindling cash balances or raise debt to finance the Dividend, neither of which is sustainable in the long run.
5. Unaffected By Short Term Volatility
Unfortunately, due to the way the market has transitioned, most people are almost entirely focused on short term price performance of the Stocks. The result is an extremely volatile market which is driven by market rumours and breaking news which have no bearing on how much dividend you are receiving. The good thing is that you simply do not have to be too bothered by the price volatility, it’s something you learn to not take too seriously, while receiving your checks regularly.
About the Author
Calvin Yeo is the Managing Director of Doctor Wealth Pte Ltd (www.drwealth.com), which is an online financial planning platform. He is also a Chartered Financial Analyst (CFA) as well as Certified Financial Planner (CFP).
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