These steps for investing in dividend stocks can help investors understand its process and aid them in increasing their portfolio.
Steps to Invest in Dividend Stocks
Dividend Investing for a Long-Term Income
Learning how to invest in a common stock dividend may take some of the stings out of playing the stock market game. These stocks pay stockholders a dividend yield that is a small part of the company’s profits.
They might pay that yield in cash that goes right into the investor’s bank account or might provide more stock shares.
The investor’s goal in this investment is pretty simple. They want to pick stocks that will continue to provide them income for years.
Here are some steps to consider that will help investors learn how to invest in dividend stocks.
Step 1: Do Research on Dividend Investing
It’s important to do research before making any stock purchases. Not all stocks are dividend stocks, for example.
With some stocks, the investor only makes money when the stock prices go up. With dividend stocks, they earn an income when the stock price goes up and they even with the dividend yield.
Good quality dividend stocks have a dependable growth pattern for both the market price and dividend yield amount. Most companies that offer these payments are mature enough to have a history that investors can check.
Consider investing in a company that has been around for a long time with plenty of cash and a history of raising their dividend yields. A newer company will have more problems with cash flow and may cut the payment when their budget is tight.
Step 2: Make a List
Once an investor has a couple of dividend stocks in mind, they can make a list to compare the stocks with. Again, they may want to consider more than just the amount of the dividend paid.
When making a list, the investor can write down how long the company has been in business and what the free cash flow looks like as well as the dividend yield history.
They can also ask other investors of the company they are eyeing for feedback on their experiences to have better insight into the company’s performance. Feedback from other investors can definitely be a valuable asset in deciding whether to pursue an investment or not.
Step 3: Think About the Investment Plan
Short-Term Investment Plan
In some cases, investors might buy dividend stocks that have a high yield, knowing that they only plan to keep them for a short time. An investor might be saving for a new car or house and just need to tuck that money away for three to five years. In that case, they can consider picking really high yield stocks to buy.
Long-Term Investment Plan
Most people may consider buying dividend-paying stocks if they plan to invest for 10 years or more.
For long-term investing, they may want to consider going with something more secure and less volatile. As a rule, companies that offer extremely high yields on their dividend stocks have trouble making those big payments for a long time.
Stocks with a lower dividend yield, but one that has grown consistently from year to year, tend to be a safer buy. Dividend Aristocrats are stocks that have paid a little more each year to stockholders for at least 25 years.
Step 4: Look at the Reinvesting Part of the Dividends
That is how some investors make money. They take the earnings they get from their dividend stocks and compound them.
In other words, they take that money and buy more stocks.
- An investor buys 100 shares of the Acme stock for $5,000
- The company pays an annual reward of $1.50 per stock
- The investor then makes $150 that first year
Carrying forward this example:
- Let’s say an investor bought Acme stock because they did their research and knew that the company averages a 5% increase in payments each year
- If they reinvest all their payments for 20 years without buying any more stocks with money from their savings account, that $5,000 will turn into almost $14,000.
Therefore, it is worth more because they have only used dividend payments to buy additional stocks.
Step 5: Consider a DRIP Program
Companies that deal in stock investing offer a service known as DRIP or Dividend Reinvestment Plan. They put together a group of investors and automatically reinvest dividend yields into the plan depending on the dividend payout ratio.
DRIP Definition: A plan offered by a company allowing investors to invest their cash dividends again into additional shares of an underlying stock on the dividend payout dates.
When the share price is paid, the investment firm buys more stocks with that money. An investor just has to sit back and watch their investment grow.
Using a DRIP service means a professional investor looks at the various dividend stock options for an interested investor. They do all of the research and then present options to the interested investor.
There is usually a fee involved, but an interested investor might be able to buy additional stocks without paying a fee or for less money.
Keep in mind though that the DRIP service fee comes out of an investor’s profits from buying the monthly or quarterly dividend stock. Also, the investor should make sure they take time to read all the terms before entering into a DRIP program to ensure it is the right choice.
Step 6: Consider Dividend ETFs
Another option is the dividend ETF. Exchange-traded funds, or ETFs, are investments like stocks, but ETFs work a little differently.
Investing in a Stock vs Investing in an ETF
- When an investor buys a stock, they are investing in one specific company.
- When they invest in ETFs, it’s more like a grab bag of different things that make money. An ETF combines different securities, including stocks, bonds, or commodities.
Certain kinds of ETFs are based on a bag full of dividend stocks and usually ones with high yields. When looking at ETFs, investors might want to consider a few things, including the fee for managing the plan.
That payment comes out of the dividend yield, so investors make less if it is high. They also might want to know how the ETFs went about picking their dividend stocks.
Companies involved in ETFs should do all of the research for the investor, plus more if the investor picks stocks to buy themselves.
Step 7: Build a Dividend Growth Using Roth IRA
If an investor’s primary goal is to fund their retirement or simply to save money tax-free, creating their growth portfolio in a Roth IRA might be a good option. A Roth IRA is a special retirement account that an individual can fund using post-tax income.
Instead of paying a tax on dividends every year, the payment for dividends is left in this type of IRA. This means the tax savings can grow into thousands of dollars over time primarily because of the interest growth a year in an investor’s account.
A Roth IRA is a good investment vehicle because an investor can grow their money tax-free with qualified withdrawals. The higher an investor’s portfolio turnover rate, the greater their tax savings in a Roth IRA.
What’s good about a Roth IRA is that it does not have a minimum required distribution, so it gives investors great flexibility with their contributions. Aside from that, it does not have a mandatory withdrawal, allowing the investor’s money to continuously grow.
Investors can open a Roth IRA account at various well-known brokerages for a lesser amount per trade.
Step 8: Track Dividends
Companies do not necessarily need to pay or provide shareholders with dividends. This means they have the freedom to eliminate, raise, or lower dividends at any time.
This is tricky at some point though because companies that are stable may opt for withholding dividends to get into a new sector or create a new product. Failing companies may provide paid dividends to a shareholder to create an impression of success, which can attract new investors.
What an investor can do instead is to track their dividends using their brokerage account so they know where they stand and if they are making the right decisions. If they can monitor the performance of their dividends, they can forecast how much to invest and save to achieve their goals.
They can also consider selling their stock if dividends fall at a threshold below their goal.
When an investor learns how to invest in regular dividend stocks and decides to invest in one, they are taking a chance.
Dividend growth stocks are also another way to invest. Dividends make the stock a little safer because they offer an additional way to make money.
If investors are planning to invest for a long time, they should look for dividend stocks to sweeten the pot.
Do you have questions or need clarification on investing in dividend stocks? When are you going to start investing in dividends? Please let us know in the comments section below.
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Editor’s Note: This post was originally published on May 3, 2018, and has been updated for quality and relevancy.