Benefits of Dividend Investing
Dividends offer numerous benefits to investors as well as the companies that pay them. Let’s start with an overview of some of the benefits dividends offer to you, the investor.
Dividend Stock Investing
Unlike many other forms of investing, there is a low dollar amount required to become a dividend investor. If you can afford to buy shares of a dividend paying stock, you can invest for dividends. Of course, this low barrier to entry is appealing to many investors, particularly younger investors.
The fact that dividends can create a consistent stream of passive income is their biggest appeal. Dividends allow you to earn income simply by owning a stock. Furthermore, this income is likely to increase overtime if the company increases the dividend yield, the share price goes up, or you accumulate additional shares.
Safety in a declining market
Dividend investing can also provide safety in a declining market. Keep in mind, investing in stocks, including dividend paying stocks, involves inherent stock risk. Even a cursory look at a stock chart will show that stock prices fluctuate. But, in a steep stock selloff, the dividend will provide support for the stock’s price.
As the price declines, the dividend yield increases. That means you are paying less and less for the right to the dividend payment in the future. If investors believe the company can continue to support the dividend payment throughout the downturn, they will buy shares when yields reach a certain level.
Dividends won’t keep a stock’s price from fluctuating, but they will allow you to continue to generate some sort of return even if the stock’s price declines.
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An under-appreciated benefit of dividend investing is that because you still receive your dividend, you may be less likely to sell your shares when the price declines. This emotional influence keeps you from locking in a potential loss and positions you to participate in a rebound.
One of the more powerful aspects of dividend investing is that it can help reduce inflation risk. Historically, dividends have outpaced inflation. Over the past 150 years, inflation has grown at a rate of 2% per year, but dividends paid by U.S. companies have grown 3.7% per year. This is a significant benefit to investors as it provides a way to overcome the loss of purchasing power that is a result of inflation.
Dividend investing can also lead to compounding growth over time. For many investors, one of the primary goals is to create long-term wealth by multiplying their money. If you reinvest the money you make from dividends, you allow that money to make even more money. Thereby creating a cycle of exponential growth overtime.
Benefits to Dividend Paying Stocks
Companies are not required to pay dividends, and not all do. So, why would a company choose to pay its shareholders a dividend? In other words, what’s in it for them?
First, dividends are a fantastic way for companies to attract and retain shareholders. All things being equal, many investors prefer to invest in a company that allows them to participate in its profits. As previously stated, investors are less likely to sell their dividend paying stocks when the price declines. The ability to retain shareholders is unquestionably a benefit to the company that pays a dividend.
Paying a dividend also allows a company to demonstrate financial strength. Dividends are a clear message that a company has solid prospects for the future. Simply by being willing to pay a consistent dividend, the company is indicating that it feels confident about its financial health and potential for strong performance over time. Most companies won’t implement a dividend policy if they don’t believe they can support the payment indefinitely.
This clear sign of financial strength, as well as the appeal of dividend paying stocks to investors, can create a greater demand for a company’s stock and result in an increase to its price.
Simply stated, paying dividends is a good use of a company’s extra cash. The commitment to paying a regular dividend shows a higher level of demonstrated discipline that implies a company is less likely to waste money and take on excessive debt.
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