If you are looking for a way to invest in the stock market that can provide you with steady income and lower risk, you may want to consider dividend stocks. Dividend stocks are stocks that pay out a portion of their earnings to shareholders on a regular basis. In this blog post, I will explain what dividend stocks are, why they are attractive in uncertain times, and how to choose the best dividend stocks for your portfolio.
What are dividend stocks?
Dividend stocks are stocks that distribute cash payments to their shareholders, usually every quarter or every month. Dividends are a sign of a company’s financial strength and stability, as they indicate that the company has enough cash flow to reward its investors. Dividends also provide investors with a source of income that can help them weather the market volatility and supplement their other sources of income, such as salary, pension, or social security.
Why are dividend stocks attractive in uncertain times?
Dividend stocks are especially attractive in uncertain times, such as the current situation, where the trade war, the political turmoil, and the economic slowdown are all factors that can affect the performance of stocks. Dividend stocks can offer several benefits in such times, such as:
- Higher returns: Some dividend stocks have higher yields than others, meaning they pay out more dividends relative to their share price. These high-yield dividend stocks can offer more attractive returns than bonds, which have low interest rates right now. According to analysts, 60% of the stocks in the S&P 500 have dividend yields that are higher than the 10-year US Treasury Note. For example, Occidental Petroleum Corp. ($OXY) and AbbVie ($ABBV) have dividend yields of 6.7% and 6.5%, respectively.
- Lower risk: Dividend stocks tend to be less volatile than non-dividend stocks, as they have more stable and predictable cash flows. Dividend stocks also tend to be more resilient in bear markets, as they can cushion the losses from capital depreciation. Moreover, dividend stocks can benefit from the compounding effect, which means that reinvesting the dividends can increase the value of your investment over time.
- Tax advantages: Dividend income is taxed differently than capital gains income, depending on your tax bracket and the type of dividend. Qualified dividends, which are dividends paid by US corporations or qualified foreign corporations, are taxed at a lower rate than ordinary dividends, which are dividends paid by other entities. Qualified dividends are taxed at the same rate as long-term capital gains, which range from 0% to 20%, depending on your income level. Ordinary dividends are taxed at the same rate as ordinary income, which can go up to 37%.
How to choose the best dividend stocks for your portfolio?
Not all dividend stocks are created equal. Some dividend stocks may have high yields, but also high risks, as some companies may cut or suspend their dividends if they face financial difficulties. Therefore, it is important to do your research and look at the fundamentals of the companies before investing in their stocks. Here are some factors to consider when choosing dividend stocks:
Dividend yield: This is the annual dividend payment divided by the share price. It shows how much income you can get from a stock relative to its price. A higher dividend yield means a higher income potential, but it can also indicate a higher risk, as it may reflect a low share price due to poor performance or a high dividend payout ratio that may not be sustainable. A good rule of thumb is to look for dividend stocks that have a yield of at least 3%, but not more than 10%.
Dividend growth: This is the annual percentage increase in the dividend payment. It shows how much the company is willing and able to raise its dividends over time. A higher dividend growth means a higher income potential, as it can offset the effects of inflation and increase the compounding effect. A good rule of thumb is to look for dividend stocks that have a dividend growth rate of at least 5% per year for the past five years.
Dividend payout ratio: This is the percentage of the earnings that the company pays out as dividends. It shows how much the company is retaining for reinvestment and how much it is distributing to shareholders. A lower dividend payout ratio means a lower risk, as it indicates that the company has enough earnings to cover its dividends and invest in its growth. A good rule of thumb is to look for dividend stocks that have a dividend payout ratio of less than 60%.
Dividend history: This is the track record of the company’s dividend payments. It shows how consistent and reliable the company is in paying and increasing its dividends. A longer dividend history means a lower risk, as it indicates that the company has a strong commitment and ability to reward its shareholders. A good rule of thumb is to look for dividend stocks that have paid and increased their dividends for at least 10 consecutive years.
Another way to invest in dividend stocks is through exchange-traded funds (ETFs) that focus on dividends. ETFs are collections of stocks that track a certain index or theme. By investing in dividend ETFs, you can diversify your portfolio and reduce your exposure to individual stock risks. Some of the largest and most popular dividend ETFs are:
- Vanguard High Dividend Yield ETF ($VYM), which tracks the performance of the FTSE High Dividend Yield Index, a basket of high-yield US stocks.
- SPDR S&P Dividend ETF ($SDY), which tracks the performance of the S&P High Yield Dividend Aristocrats Index, a basket of US stocks that have increased their dividends for at least 25 consecutive years.
- iShares Select Dividend ETF ($DVY), which tracks the performance of the Dow Jones US Select Dividend Index, a basket of US stocks that have a consistent dividend payment history and a high dividend yield.
However, investing in dividend stocks is not without risks. One of the main risk factors that can affect the stock market is the uncertainty over the economic policy in the United States. According to a CNBC report, the economic policy uncertainty index, which measures the unpredictability of the government’s actions, is at its highest level in three years. This uncertainty can lead to increased volatility in the stock market, as investors react to the news and rumors.
One interesting statistic that illustrates this volatility is the correlation between President Trump’s tweets and the market performance. According to an Investopedia article, since 2016, on days when President Trump tweets about the market 35 times or more, the market is, on average, down. This frequency of tweeting occurs around 10% of the time. On the other hand, on days when President Trump tweets five times or less, the market is, on average, up. This also happens around 10% of the time.
Of course, this does not mean that President Trump’s tweets cause the market movements, but it does show how sensitive the market is to the political and economic news. Therefore, as an investor, you should be prepared for the market fluctuations and have a long-term perspective.
In conclusion, dividend stocks are a great way to invest in the stock market that can provide you with steady income and lower risk, especially in uncertain times. However, you should also be aware of the risks and challenges that come with investing in dividend stocks, and do your homework before choosing the best dividend stocks for your portfolio. Happy investing!