How to Invest in Dividend Stocks & ETFs
Anyone who wants to create a passive income with equities should know how to invest in dividend stocks. Many stocks pay a portion of their profits back to investors with regular payments, called dividends.
Much in the same way that a bond or bond fund will create a passive income, dividend stocks make it simple to buy an asset and create a revenue stream. There are also ETFs that specialize in paying dividends, which are a great way to buy a range of individual stocks at once.
Like any kind of investment, buying dividend stocks requires some amount of education. There are many kinds of stocks and ETFs that pay dividends, and also some potential risks that need to be understood.
Dividend Paying ETFs
There are a few ways to create a portfolio of dividend-bearing stocks. Probably the easiest is to buy a few ETFs that pay dividends. You can also research individual stocks and create your own basket of dividend-paying companies, which is substantially more work. REITs are a specialized company structure that is designed to return capital to investors, and they also may be worth a look.
Buying ETFs that pay dividends are just like buying any other kind of ETF, but you will need to look at a few metrics before you pull the trigger. One of the biggest advantages to buying dividend-bearing ETFs is that the company that manages the ETF does all of the research for you. These ETFs will have built-in diversification, which is another great point.
Important things to consider when buying a dividend ETF:
- Expense Ratio: The company that manages the ETF you are analyzing charges for its services. This is called the expense ratio. Clearly, lower is better. If the Expense Ratio is above 0.50% per year, it would be worth looking for a cheaper one.
- Dividend Yield: This is how much the ETF (or a company) will pay as a percentage of its market price. Like all things, this rate will change as the component companies add or subtract to their dividends, and the price of the ETF's shares fluctuate.
- Five Year Returns: The opposite of an expense ratio...higher returns are your goal!
- Market Cap of Component Companies: In general, an ETF will have guidelines about the size of the companies that makes a part of the fund. There are no rules about what company size will make the best investment, although large-caps tend to be more liquid, and less volatile.
See how easy buying dividend ETFs can be!
Build Your Own Dividend Stock Portfolio
If you decide to build your own dividend stock portfolio, it will almost certainly be more focused than a dividend stock ETF. There are a few things to consider before you go this route, and start sifting through the thousands (or more) stocks in the US markets that pay a dividend.
- Risk vs. Outperformance: It is almost always true that when a portfolio has less diversification, it will move more than the overall market in percentage terms (also called 'beta'). If you are a good stock picker, this could be an advantage, although very few people can beat the markets over the span of a few years.
- Time Involved: Don't underestimate the amount of time it will take to sort through all the stocks that pay a dividend. In order to create a dividend stock portfolio, you will need to dedicate time not only to create the portfolio but also to keep on top of all the changes companies make.
- Dividends Rise and Fall: In addition to probably having a higher beta, a more concentrated dividend stock portfolio will be sensitive to changes in the dividends at the component companies. If one of the companies lowers the payment or cuts the dividend entirely, the impact on your overall portfolio will likely be much higher than it would be with an ETF.
What About REITs?
A REIT, or Real Estate Investment Trust is a classification of company that allows investors to buy and sell shares in an entity that owns revenue-producing real estate. These shares are traded on major exchanges and are extremely liquid.
REITs made a lot of sense for the last few decades, as commercial real estate has been a great investment. Now that the global economy is showing signs of stress, any real estate investments that rely on tenants paying rent should be viewed with more caution.
Keep Your Income Streams Diversified
Dividends aren't like interest payments from a bond. Companies can and do cut or eliminate dividends, which makes diversification even more important for dividend stock investors.
You should also be cautious of a company that is paying a very high dividend, as this may mean the stock has been sold down, and the company will be slashing the dividend in the near future.
The Bottom line:
Dividend stocks are a good way to gain exposure to the capital appreciation that equities offer, and also create income. Reinvesting your dividends after they are paid can also help you boost your income over time, and grow your exposure to a company or fund.
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