For many investors, dividend stocks represent the perfect balance in an investment. Dividend stocks provide reliable, regular income to their shareholders, making it possible to draw income from a portfolio. Yet the best dividend stocks also have underlying businesses that have continued earnings growth prospects, allowing for the potential for share price appreciation and long-term gains. Although there are many strategies to help dividend investors take full advantage of companies that pay regular dividends, three main strategies stand out from the rest. They include:
- Investing in dividend stocks with above-average dividend yields
- Investing in dividend stocks with long histories of rising dividend payments
- Investing in exchange-traded funds that focus on dividend stocks
We'll look at each of these methods of investing in dividend stocks below.
Investing in dividend stocks with above-average yields
For many dividend investors, the primary goal is maximizing current income. To do so, you can simply look at lists of stocks ordered by dividend yield and then pick the highest-yielding stocks available. That will result in the most cash flow coming from your portfolio, at least in the short run.
The problem with blindly picking high-yield dividend stocks is that they can be extremely dangerous. For instance, if a company routinely pays out more in dividends than it brings in through earnings, then the sustainability of the dividend for the future can come into question. Many high-yield stocks eventually have to cut their dividends, resulting in both a loss of income for shareholders and dramatic declines in the share price of the stock.
It's therefore critical that investors be smart about choosing the high-yield stocks with the healthiest fundamental business prospects. That way, the odds will be better that the stock will avoid dividend cuts in the future, letting investors keep collecting regular payments over the long haul.
Investing in dividend stocks with long track records of dividend growth
Many dividend investors don't just focus on current income, either because they don't immediately need the income or because they want to focus on the long-term growth of their income stream over time. For these investors, an alternative to high-yield dividend investing involves looking at the dividend histories of companies to look for the most attractive growth trends.
You can find lists of stocks that have particularly excelled at dividend growth. The members of the prestigious S&P Dividend Aristocrats list have raised their annual dividend payments to shareholders each and every year for at least a quarter-century, and as members of the S&P 500 Index, all of the Dividend Aristocrats are well-established companies that have demonstrated their ability to overcome downward cycles of the economy. Being a Dividend Aristocrat is no guarantee that a future dividend cut won't come, but the risks are generally lower than with high-yield stocks, and many Dividend Aristocrats themselves have solid yields that won't leave investors scurrying to make up lost income.
Investing in dividend ETFs
Finally, if you don't want to pick individual stocks, you can find exchange-traded funds that specialize in dividend stocks. For instance, the Vanguard High Dividend Yield ETF (NYSEMKT: VYM) follows the first strategy above, seeking above-average yielding dividend stocks that meet the fund's standards for quality and financial sustainability. The Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) focuses instead on dividend stocks that have grown their payouts over time.
In choosing a dividend ETF, you'll want to focus on several things. First, low fees will ensure that more of your dividend income flows through to you as a shareholder. Understanding the methodology of the ETF is essential so that you know what sort of exposure you're getting, including how various holdings are weighted within the portfolio and what conditions must be met for the fund to hold a certain stock. Finally, look at any potential discounts available with ETFs, such as the commission-free arrangements that several brokers have with various ETF providers.
Investing in dividend stocks can help give you the best of both worlds. Which of these strategies is best for you will depend on your particular appetite for risk and the amount of time you want to spend looking at potential investments. By enhancing your income and offering solid total returns, any of these three dividend strategies could give your portfolio a valuable boost.
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