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Is it better to invest in stocks that will appreciate in time with a high value sell off or hold on stocks that will give high dividend returns?

Is it better to invest in stocks that will appreciate in time with a high value sell off or hold on stocks that will give high dividend returns?

Investing, Stocks, Starting Out
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March 2019

Danford, Dan

Saint Joseph - Kansas City, MO

It’s a good question because you hear so much about “dividend-paying stocks.” It is important to understand that most common stocks (as opposed to preferred stocks) could start paying dividends if the board of directors decides. By the same token, a stock which pays a regular quarterly dividend could stop if the board of directors decides to refrain. So, from that standpoint, common stock dividends aren’t guaranteed even if they have a long track record of paying regular dividends.

So why are dividends appealing? Some corporations generate strong cash and profits each new year. The dividends are a way to pass those profits along to the corporation’s owners. For people needing regular income, that quarterly dividend provides income they can spend.

Why wouldn’t a corporation pay dividends to shareholders? Some companies face such attractive opportunities that any cash or profits can be used to grow the business. Maybe they buy new machinery or inventory or expand into new markets. Capital used for those purposes could make the company even more profitable, potentially driving the share price up for all owners. Corporate boards weigh all these factors in deciding to add, adjust, or suspend dividends.

Is one approach better than the other? It depends on what you want and need. If you need cash income, then dividends can buy your groceries. If you don’t, growth might be a stronger option.

It’s also important to consider other aspects of a corporation. Dividend-paying corporations tend to be big and mature; utility companies, perhaps, or maybe a bank or manufacturer. These companies tend to have stable earnings, even if they might not offer the same growth prospects as a smaller, nimbler, emerging company. Looked at like this, dividend-paying companies tend to have less price volatility than others. They will generally perform better in down markets.

A red hot economy, though, boosts opportunity for growth companies. You likely won’t collect cash dividends, but a stock’s price could rise magnificently as the company grows in market-share or profits.

One last thought: dividends are taxable in non-retirement accounts (actually, they are taxed at the corporate level before they are passed along to you – so-called double taxation). So, if taxes are already a challenge for you, you might prefer stocks with low or no dividends.

This is the good news. There are hundreds of each to choose from. You can tailor your stock portfolio to own mostly one, mostly the other, or a strong mix of both. Diversification is key to reducing risks, and that is true in choosing dividend- or growth-oriented stocks, too.