Dividend investing is a great way to make extra cash. If you focus on solid companies that regularly increase their dividends, a small amount can grow to become significant. Before you dive into dividend investing, here is what you need to know.
The main reason is that you will gradually become rich. Companies that pay dividends are more stable and mature than those that do not. Although they will not skyrocket suddenly, a portfolio of dividend stocks can build a lot of wealth in the long-term. Upcoming companies do not pay dividends. They feel they should reinvest their profits and grow the business instead.
When a company has grown and does not need to reinvest all its earnings, it can pay back capital to shareholders in two ways; share buybacks or dividends. According to investors, no one way is better than the other and most dividend stocks combine the two.
Dividend stocks are mainly profitable and so they always have a better chance of surviving crashes and recessions better than their non-dividend counterparts. They are also less volatile. Dividend yield is the least important of all the other metrics that major investors should be conversant with. A higher dividend is preferable (if all other factors are equal) but if a stock pays a reasonable yield, then you should concentrate more on other factors.
Long-term investors consider dividend growth and consistency more important than the current yield of stock. If you decide to invest in dividends, you should be aware of a few important dates. These dates will help you know when you will get the next dividend payment of a stock. Trade date: this is the date you bought your stock. Contrary to what you may think, the ownership of the stock is not immediately transferred to you. Settlement date: for stocks, this refers to three business days from the trade date.
This is when your purchase is finalized, and you are officially a “shareholder of the record”. Ex-dividend date: this is when a stock first trades without its dividend. You are entitled to a dividend payment if you purchase shares before the ex-dividend date. Record date: this is two business days from the ex-dividend date. On this date, the company determines who does and does not get a dividend. Pay date: this is when shareholders are paid a dividend.
If you want to invest for the long run, reinvest your dividends so that you can maximize your returns. If you are a new investor, it is wise to start with an ETF that deals specifically with dividend stocks. All the knowledge can be overwhelming to a new investor so investigate the index-fund approach. This is a smart way to get into dividend investing safely.
The only shareholders a company has when it is first formed are early investors and co-founders. For instance, if a startup company has one investor and has been founded by two individuals, each one of them will probably own a third of the shares of the company. As the company continues to grow, more capital will be needed to facilitate the expansion. Consequently, it will issue more shares to interested investors. Eventually, the founders will have a smaller percentage of the shares.
At this point, both the firm and its shares are private. Private shares are not exchanged easily in most cases and the number of shareholders is usually not big. As the company becomes bigger, the early investors will want to sell their shares and cash in the profits of their investment. Again, the company may require more capital and the few investors may not be able to offer what is needed.
This is when the company considers an IPO (initial public offering) and transforms into a public company. Other than the public/private distinction, companies can issue two other types of stocks: preferred shares and common stock. Any time you hear people talk about stock; they usually mean common stock. This is the most issued form of stock. Common shares come with voting rights and represent dividends (or claim on profits). Investors commonly get one vote for each share to elect board members.
These board members oversee the key decisions in the company. Common stock tends to have higher returns over the long run (by means of capital growth) compared to corporate bonds. Now, this higher return does not come without a cost. Common stock comes with very high risks including the risk of losing the entire invested amount should the company go out of business.
If the company declares bankruptcy and liquidates, common shareholders only receive money after preferred shareholders, bondholders, and creditors have been paid. Preferred stock is more like bonds in terms of function. Preferred shareholders do not have voting rights (some companies are different). With preferred stocks, the shareholders are assured of a fixed dividend in perpetuity. Common stock is different here in that it has variable dividends which are never guaranteed—the board declares these dividends.
As a matter of fact, most companies do not even pay out dividends to common shareholders at all. Another advantage of preferred stock is that if the company liquidates, shareholders will be paid before common shareholders. However, preferred shareholders still get paid after creditors and debt holders. In some cases, preferred stock is callable. This means that the company can re-purchase the stock from a preferred shareholder for any reason at any time. Preferred and common are the two major forms of stock. However, companies can customize various classes of stocks depending on the needs of their investors.
The main reason for companies to create share classes is to keep voting power within a specific group. In this case, different classes of stock have different voting rights. Any investor that wants to be successful in the current financial marketplace must maintain their portfolio well. You must know how to allocate assets to best suit your risk tolerance and investment goals. Using a systematic approach, investors can create a portfolio that is aligned to their investment strategies. Here are the steps to help you take such an approach.
Step 1: Know the Right Asset Allocation for You – The first step in building a portfolio is understanding your current financial situation and your goals. Some of the important factors you should consider include your age, the time you have, future income needs, and the amount of capital at your disposal. Another thing to have in mind is risk tolerance and personality. Can you willingly risk your money in the hope of future returns?
All investors love the idea of reaping profits year in and year out. However, if a short-term drop is likely to give you sleepless nights, then maybe you should stay away from high-return assets. When you understand your risk tolerance, future capital needs, and current situation, you will be able to determine how to allocate your investments among different classes of assets. The potential of high returns is usually accompanied with a higher risk of losses.
Step 2: Achieving the Portfolio After deciding on the perfect asset allocation, it is time to spread your capita over the right asset classes. This is easy on the basic level; bonds are bonds and equities are equities. You can, however, divide the asset classes further into subclasses; they also vary in terms of potential returns and levels of risks.
In choosing securities and assets, you can use several methods to suit your strategy. Stock picking: ensure that the stocks you pick are in accordance to your risk tolerance. Use stock screeners to analyze companies and narrow down your options. Bond picking: consider the interest-rate environment, bond type, rating, maturity, and coupon. Mutual funds: you can opt for those that are picked by professional fund managers.