Stocks that pay dividends have helped millions of investors become wealthy. But not all dividend stocks are the same. Before you simply pick a few for your portfolio, you need to get a grasp on one of the major differences among the thousands of stocks that pay dividends.
Should you get paid now or later?
Investors choose dividend stocks for a variety of reasons. Some pay more attention to the company and its future prospects and happen to pick a stock that pays a dividend, with the dividend not really playing a major role in their investing decision. Others see dividend stocks as being categorically more conservative than their non-dividend-paying counterparts, and so they don't necessarily focus much on the particular attributes of the companies whose stocks they buy.
The most obvious reason to buy dividend stocks, though, is for the income they generate for investors. With interest rates on bonds and other fixed-income securities so low right now, dividend stocks are among the best ways to create a steady stream of cash. But there are two very different strategies that income-seeking investors can follow to maximize their dividend income. Which one you pick depends largely on whether you need more income now or in the future.
Eating your dessert first
If you don't want to delay gratification -- or you don't have the time to wait -- then high-yield dividend stocks look the most attractive. Those seeking for the highest yields have a huge array of choices to look at:
- Real estate investment trustAnnaly Capital Management (NYSE: NLY ) has maintained a double-digit dividend yield for two years now, as it has used ultra-low rates to leverage its investment in Fannie Mae and Freddie Mac bonds.
- Old-fashioned telecoms AT&T (NYSE: T ) and Verizon (NYSE: VZ ) may not have much growth left in their landline businesses, but both have yields approaching 7%. Some of their smaller competitors sport even higher payouts.
- Master limited partnership Magellan Midstream Partners (NYSE: MMP ) sports a 6% yield right now. Even better, its payout has some tax advantages that let you keep even more of what you earn than with regular stocks.
The thing about high-yield stocks is that you have to be particularly vigilant. Often, high dividends are unsustainable and express concerns about whether the stock will be able to continue paying them. BP shareholders found this out the hard way recently, when a 10% dividend yield turned into nothing when the company suspended its dividend payments.
As a result, some dividend investors who don't need to maximize their income right away instead look away from high-yield stocks. Instead, they focus on stocks with more modest payouts now but which also have a track record of growing their dividends significantly over time.
For instance, Procter & Gamble (NYSE: PG ) is a stable stock with a 3% dividend yield. That may not sound like a whole lot, but far more important for long-term investors are two facts: the company has raised its dividend in each of the past 57 years, and the annualized growth rate over the past five years is close to 12%. If that rate continues, then you'll see your dividend double every five or six years. Hold your shares long enough, and you might see your annual dividend payments exceed the total amount you paid for your stock!
P&G is a good stock, but it's not the only one. Fellow stalwart McDonald's (NYSE: MCD ) has a similar history and has more than tripled its dividend since 2005. Chevron (NYSE: CVX ) combines a relatively high 3.9% yield with 11% annual growth over the past five years, and more than two decades of raising its payouts each year.
You win either way
Which of these strategies you choose comes down to a matter of individual preference. If you need as much money as you can draw from your investments right now, then high-yield dividend stocks will be best for you. If you have time, however, to let your investments grow, then stocks with lower payouts now might blossom into even better payers down the road.
Don't discount the power of dividend stocks. Even if you don't need income from your investments today, chances are you will eventually. There's never been a better time than now to add dividend stocks to your portfolio.
If you want to learn more about dividend stocks, tune in to Nathan Alderman's roundtable on the best dividend stocks for beginning investors.
Fool contributor Dan Caplinger likes the slow and steady route to wealth. He doesn't own shares of the companies mentioned. Magellan Midstream Partners and Procter & Gamble are Motley Fool Income Investor choices. The Fool owns shares of Procter & Gamble. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy pays you back every day.