Is investing in stocks with quarterly or monthly dividends a good strategy for saving for retirement?
Investing in the stock market will always have risks. But generally, investing in the stocks of companies that pay dividends can, over time, result in lower risk, lower volatility or variablity of prices, and provide income.
Dividends are paid out by companies to the stock owners. Aside from Real Estate Investment Trusts (REITs), no company is ever required to pay out a dividend.
Stockholders receive a return on their investment in two ways: Dividends and/or capital gains. Most folks focus on the "buy low, sell high" side of things hoping to score big by buying in at the ground floor of the next Microsoft of Apple. Dividends are typically paid out by a company's management when the company feels that they cannot find as good a use for the net profits by reinvesting in the company. So, they return a portion of the profits back to stock holders.
So, most companies that pay out dividends tend to be large with very stable or established products and customers. They tend to not be flashy, sexy startups. As a result most dividend-paying stocks tend to be slower growth type firms. They may be considered boring or are positioned as "value" stocking versus "growth". This is not an entirely bad thing. Remember the tortoise beat the hare and in investing consistency rules.
But remember that boring can be good for you in the long run. By receiving a dividend, you can increase your current cash flow or you can use the payout to buy more shares in the company. Over time you'll build a significant position in stocks that may provide an income stream in retirement, one that you don't need to rely on the stock market to provide in the form of higher stock prices.
Dividend-paying stocks can act as a hedge to one of the greatest risks for any retiree: inflation. And research has shown that stocks that pay out a dividend tend to better over time than those that don't. Further research also has shown that the stocks of companies that pay out an increasing dividend tend to do better than both non-dividend paying stocks and stocks with static dividend payouts.
A $1,000 investment spread equally amoung 100 of the highest dividend-yielding stocks starting on January 1, 1957 through December 2009 would have accumulated more than $450,000 assuming reinvestment of dividends. This would have been a 12.5% annual return which would have beat the S&P 500 index by 2.5%.
I tend to recommend and use mutual funds, Exchange Traded Funds (ETFs) or individual stocks of companies that have a history of growing their dividends. These are sometimes referred to as "dividend growers". The most exclusive among these are the companies that have consistently grown their dividends every year for at least twenty (20) years. These are referred to as "Dividend Aristocrats". Then in a class by themsleves are the stocks of companies that have grown their dividends every year for at least fifty (50) years. These are referred to as "Dividend Kings".
Most of these companies are not going to be sexy to talk about. But they are consistent. And that means you'll have a lower risk profile in your portfolio if you hold some of these.
To protect yourself, you'll want to limit your exposure to companies that have a sustainable payout. Experts may haggle about this point but generally you should look at companies that limit their payouts to no more than 65% of their net profits. There are all sorts of additional filters you can consider. For instance you can limit your stock selection to those with a payout at least equal to the S&P 500.
It's awesome that you're doing your own investing, and getting started at the age of 25. Stocks that pay out (usually quarterly) dividends tend to have nice cash flow, which typically indicates sounds financial footing. Beware a trap here though. There are some companies that pay very high dividends, because of the structure of those companies. Companies like Blackstone (Ticker: BX), Digital Realty (Ticker: DLR) are companies that pay very nice dividends, but companies in their sectors usually pay high dividends. I actually like both of these companies, but the more important thing to consider is do these companies have staying power? Are they leaders in their industry or do they have some form of competitive advantage over their peers? Take Amazon as an example. Amazon has an amazing knack for disrupting industries yet they pay no dividend (really because they don't have high profit margins and they keep reinvesting it back in the business). Illumina (Ticker: ILMN) has done great work in mapping the human genone in the healthcare space. Tesla (Ticker: TSLA), despite its product problems, has the opportunity to disrupt not just the automotive industry but also the solar power industry. There is much more to picking a strong company than picking a company with a dividend. Often times a strong company will pay you a dividend, but paying a dividend is not necessarily indicative of staying power. In addition, in a bear market many companies will lower or shut off their dividend. Prior to making a purchase I would go to a website like SeekingAlpha.com and seeing what others say about that stock. Investopedia also has a great tool where you can invest in companies without using real money. It's a great way to cut your teeth without losing real money until you figure out your routine.
Since you are just getting started I would suggest picking a few that you really like and then blending it with passive ETF. The diversification from the ETF will help control the risk of being overly concentrated in a few individual positions.
The best strategy for building wealth is to hold investments with the best total return. "Total return" is the sum of price movement and dividends. In general, a company that pays a high dividend does so because they don't feel that they have anything better to do with the money that return it to the owners (shareholders, including you.) This is often true of large, mature, slow-growing companies. There is no good reason not to own a large, slow growing company if it is financially sound and well managed. It ought to grow with the world economy and pay you a modest yield while it does. Often, companies like this will raise their dividend every year. Just please understand that if such a company did not pay a dividend its cash would accumulate and contribute to growth in the stock price. So getting a dividend and calling it "income" is kind of like drinking your own blood and calling it "nutrition."
Most of your portfolio ought to be invested for growth. Find good quality companies who can sustain a rate of growth that exceeds their competition, keep an eye on their fundamentals, and hold for the long term (or until the growth looks unsustainable). It won't matter that they don't pay dividends because they can earn you a higher return by investing their free cash in their business instead of giving it to you.
Brilliant! Dilly-Dilly! Yes!
Younger investors tend to forego dividend stocks for the sexier hot growth stocks. But dividends compound, growth doesn't. By reinvesting your dividends, they buy more shares, which in turn pay dividends, which buy more shares.... Einstein claimed that compounding is the eighth wonder of the world. I'd go with Albert!
By starting now, you will compound your way to a higher, stable income for your retirement life, and have the opportunity to pass on a financial legacy. Besides Einstein, Warren Buffet is a big fan of dividend investing, (so am I :) ) You'll be in good company.
Absolutely! It's not necessarily the only criteria and I wouldn't try to pick the stocks yourself. Warren Buffet instructed his estate be invested in an S&P 500 index fund after he dies because he believes it will outperform other options. When you buy the S&P 500 index, you are benefiting from the dividends paid by the companies owned which are reinvested and purchase you more shares.
Congratulations on thinking about investing at a young age! Start now and it will pay big dividends later...literally in this case...:)