Putting together a portfolio of stocks that pay dividends is one strategy to receive a regular income stream from your investments. Companies that pay dividends make regular payments to shareholders, typically in the form of cash payments. However, they may also pay out in the form of stock dividends, or extra shares of stock. They might also offer special dividends once a year if a company has an excellent year or in the form of property dividends.
Instead of choosing from just one or two dividend stocks, you may want to build up a dividend stock portfolio to make sure you benefit widely and consistently from dividend stocks. As long as you choose the right stocks, it's a good strategy to use to develop your portfolio.
In this article, we'll explore "why dividend stocks?" and walk through the steps of building dividend stocks portfolios. Let's dive in.
Why Dividend Stocks?
Dividend stocks are one way to receive regular cash payments. It can be a way to live off of investments or a retirement plan for later on. Some investors approach dividend investing by utilizing a monthly dividend portfolio method, where you align payment schedules to receive payouts for each month of the year.
There are a few other great reasons to invest in dividend stocks, including the fact that they offer growth and expansion of profits, risk and volatility mitigation, tax advantages and they can also beat inflation.
Growth and Expansion of Profits
Dividend stocks usually grow steadily over time and pay their dividend payouts from year to year. The Dividend Aristocrats or Dividend Kings have increased their dividend payouts for more than 25 years and 50 years, respectively. These companies are typically so successful that they will likely continue to keep paying out their dividends over time, so you may have reasonable confidence that they will continue to offer profitable growth as well as dividend payouts. Dividend stocks also become more attractive to investors and may increase the value of the stock.
Finally, remember that not only can you reap the rewards of the dividends companies can offer you, you can also grow wealth based on compounding. Reinvesting your dividends instead of taking them as cash will allow you to continue to purchase more stocks, and those stocks produce dividends.
Risk and Volatility Mitigation
Dividend-paying stocks can help with overall portfolio risk and volatility because dividend-paying stocks generally outperform non-dividend-paying stocks. While an overall downmarket generally drags down stocks across the board, dividend-paying stocks usually experience significantly less decline in value than non-dividend-paying stocks.
Qualified dividends are taxable at the capital gains rate, though they depend on the investor’s modified adjusted gross income (AGI) and taxable income (the rates are 0%, 15% and 20%). Qualified dividends are taxed at lower rates than ordinary income, even for individuals whose ordinary income tax rate hits the highest brackets (35% or 37%). Individuals whose ordinary income tax rate is below 12% to 35% are taxed at 15% and individuals who fall into the 10% or 12% tax brackets pay no tax on qualified dividends.
In order to benefit from returns on stocks, they have to beat inflation. Inflation is a decrease in the purchasing power of money. You may see it reflected in the general increase of prices of goods and services in the economy. Inflation can erode the results of your capital, so stocks must offer returns that can combat that inflation. Dividend-paying companies can outpace inflation.
Why Build a Dividend Stock Portfolio?
If you buy a single stock, you put all your eggs in one basket. If that single stock goes down due to a bear market, you could lose the bulk of your investment. The best reason to purchase a large number of stocks helps you gain access to diversification which allows you to weather market storms and gain better returns over the long term. Diversification helps you keep your investment assets from heavily concentrated on a single company or sector.
How to Set Up Your Dividend Stock Portfolio
If you're looking beyond investing in a single stock and want to invest in a larger dividend stock portfolio, you can take the following steps to get started.
Step 1: Determine your investment goals.
Why are you investing? Are you investing in dividend stocks for the next 10 years or do you want to invest in dividend stocks for your retirement plan? You'll want to gear your research toward the right investment stocks based on the right dividend investments for your needs.
You might want to get a financial professional on your side in order to help identify your goals. You may not know exactly how to outline your goals and a professional can help you determine what those goals should be based on your current age, retirement age and other factors.
Step 2: Research potential dividend stocks.
In order to determine the right stocks to put into your dividend portfolio, consider a number of factors for each investment you’re considering. You'll want to consider the fundamentals of the stock, the dividend yield, details in the annual letter to shareholders, contents of balance sheets and SEC filings, quarterly earnings updates and recent news. You've heard that past performance doesn't guarantee future performance. Even so, the fundamentals can reveal a lot about a company and where it's going in the future.
For example, you'll want to consider the dividend yield of several companies, which you can calculate by taking the annual dividend per share divided by the stock's price per share. If a company offers an annual dividend of $1.25 and the stock trades at $30, the dividend yield would be 4% ($1.25/$30). You can point to strong dividend yields if you find stocks that are 2% to 4%. Anything over 4% could be a great buy but it could be risky because the company might be hiding something negative.
Step 3: Set up your brokerage account.
Do you already have a brokerage account? If not, it's easy to set one up online with brokerages like Fidelity or Vanguard. Look into reliability, account minimums, fees, pricing and execution, tools, education, features and even the promotions a particular brokerage may be offering at any given time.
Your financial advisor can help you set up an account if you don't want to go the DIY route. Either way, you’ll need to offer basic information to verify your identity, including your:
- Bank account information
- Social Security number
For some people, this is the most difficult part of the process because it can be intimidating. However, pick a brokerage and move forward so your dreams of achieving a diversified dividend stock portfolio occur.
Step 4: Choose stable, diversified dividend payers.
When you decide to purchase a number of stocks, you want to make sure you choose widely diversified stocks. Diversification means that you spread your investments around so you limit your exposure to one type of investment. Put simply, you do this because it reduces your portfolio's volatility. It's a good idea to invest in a wide variety of industries and sectors, whether you buy 10 stocks or five. Investing all 10 of your stocks, in, say, the utilities sector, can mean that your entire portfolio goes down at once.
Finally, choose financial stability over rocketing growth. The companies that raise their dividends over time will likely continue to grow.
Step 5: Buy your stocks.
Identify the number of shares you plan to purchase based on their costs and choose your order type. You may choose from the following:
- Market order: A market order means that you buy or sell a stock at the best available price.
- Limit order: A limit order is a request to buy or sell at a specific price or better.
- Stop-loss order: A stop-loss order means that once a stock gets to a certain price, a market order kicks in and the order is filled at that price.
- Stop-limit order: A stop-limit order means that once a stock reaches the stop price, the trade goes into “limit order mode” and fills to the specified price limits.
Step 6: Reinvest your dividends.
Once you’ve purchased your stocks, keep them in your sights. Monitor them for volatility, returns and more. Until you're ready to take the dividends, reinvest them. In other words, if you start investing for income prior to when you want to live off the dividends.
Build Your Dividend Portfolio
Building a dividend portfolio can be a great investment opportunity to build dividend returns now or into the future. Consider a wide number of stocks (there are no specifics on the numbers that make the most sense) and the number you choose to invest in is a personal preference.
However, the most important thing to remember is to invest in more than just a small number so as to give yourself the best possible benefits of investing in dividends. Again, remember that you may want to tap into the services of investment professionals to make the best choices possible for your goals.