Dividend Investing: What It Is And How To Get Started

Dividend investing is a strategy of buying stocks that regularly pay dividends. The power of compound returns can be used to generate additional investment income on top of a price appreciation. But how exactly does this work and how can you start with dividend investing? Alphastocks tells you all about it in this article.

What is dividend investing?

Dividend investing is a strategy for generating passive income from your investments by buying stocks that regularly pay dividends. A good place to start is to compile a list of stocks with high and stable dividend payments. Then analyze each company to see if they are suitable. Buying dividend stocks is a popular approach for investors looking to generate cash flow.

Dividend stocks are often less volatile than growth stocks. Therefore, focusing on dividend stocks is an approach that appeals to investors with a lower risk tolerance. Dividend investing is a strategy that offers investors two sources of potential profit:

  1. Income from regular dividend payments
  2. Share price growth over time

When you use the dividend payments to buy more shares of the dividend paying stock, you let your portfolio benefit from what is known as enhanced compounding.

How does dividend investing work?

A dividend is a payment that a company makes to its shareholders, usually on a regular basis. Many investors, especially novice investors, are attracted to dividend investing because of the hands-off approach: you buy the stock and use the dividend payments to buy more shares. Dividends are attractive, because the dividend payout is often higher than the interest on savings accounts or bonds, for example. By putting enough money into the dividend stocks, an investor can earn regular passive income.

Benefits of dividend investing:

  • If you want to build wealth, let compounding (interest-on-interest) do its job by reinvesting the dividends over time. Each year you will have more shares as the dividends are paid.
  • Dividends reinvested provide a solid basis for generating (extra) income. In the long run, dividends are much more stable than profits or cash flow.
  • Dividend stocks are generally less volatile.
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Disadvantages of dividend investing

  • Since dividend yields are usually in the 2-3% range, you need a lot of money to generate an income that you can really live on.
  • Since all of the money paid out as dividends isn’t reinvested in the company, over-generous dividends can be a red flag. It could mean that the company loses market share, has too much debt and pays dividends on it, etc.
  • Dividend causes an immediate fall in the price. The dividend paid comes directly from the assets of the company in which you invest. As a result, the value of the company decreases proportionally to the value of the dividend paid. A dividend yield of 2% (almost always) also means a decrease of 2%. So it makes no sense to buy dividend shares for dividend and then sell it again.
  • The government sees dividend payments as income and of course tax must be paid on it. In the Netherlands, the dividend tax is 15% of the amount received, but abroad it is often higher.
  • Building up a large capital is mainly made possible by the effect of interest-on-interest in the long term. This snowball effect is caused by the fact that you not only achieve a return on your investment, but also on previous returns. If you pay dividends and don’t manually reinvest them in the stock market, you will benefit less from the interest-on-interest effect.

Tip: Watch out for stocks with a high dividend yield and a high price-earnings ratio. If their stocks are relatively expensive to begin with, dividend payers are less likely to deliver market-beating returns. Note that this is not always the case and each company should be judged on its own merits.

This article was written by AlphaStocks. Are you curious about how you can better track your investments (crypto, shares and precious metals)? Then take a look at AlphaStocks. Besides the fact that you can track your investments for free, you can also read extensive stock analyzes and various blogs!

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