Dividend investing can be a great way to generate income and build wealth over time. However, people make a few common mistakes when dividend investing, which can lead to less than desirable results. In this article, we will discuss 6 of the biggest dividend investing mistakes and how to avoid them.
- Related:
- How To Invest In Dividend Stocks: Step-By-Step Guide
- 10 Best Dividend Stocks For The Long Term
- How To Pick The Best Dividend Stocks
- The Pros and Cons of Dividend Investing
In This Article
1. Chasing high yields
Many investors look to dividend stocks as a way to generate income. And so it’s understandable when they focus on finding stocks with high yields as they’re trying to maximize their income.
However, this strategy can lead to disappointment, as high yields often come with high risk. The truth is that dividend yields are often deceiving, and a stock with a high yield might not be as attractive as it seems.
A high yield could indicate any of the following:
- The stock price is low, which could mean that the market is concerned about the company’s future prospects.
- The company is paying high dividends at the expense of reinvesting the money back into the business, which could eventually lead to lower growth and lower returns for shareholders.
- The company is raising its dividends to try and entice investors to stick around despite the company being in financial trouble.
Chasing high yields is one of the most common dividend investing mistakes that people make. When you are looking for dividend stocks to invest in, it is important to remember that higher yields do not always mean better returns. In fact, chasing high yields can often lead to investing in riskier stocks that may not be as solid as they seem.
Instead of focusing on yields alone, take a holistic approach to dividend investing. This means looking at a company’s dividend history, dividend growth rate, and payout ratio, among other things. By doing this, you can find dividend stocks that offer both high yields and stability.
2. Ignoring payout ratios
One of the most common dividend investing mistakes is ignoring payout ratios. A payout ratio is simply the percentage of a company’s earnings that are paid out as dividends. For example, if a company has a payout ratio of 50%, that means it is paying out 50% of its earnings as dividends.
Payout ratios can give you valuable information about a company’s financial health and dividend prospects. By comparing a company’s payout ratio to its peers, you can get a sense of how sustainable its dividend payments are.
If a company’s payout ratio is too high, it may not have enough cash flow to support its dividend payments. This could lead to dividend cuts or even bankruptcy. A high payout ratio could also mean that the company is not reinvesting enough of its earnings back into the business.
Conversely, if a company’s payout ratio is too low, it may not be able to grow its dividend payments at a fast enough rate to keep up with inflation. Furthermore, it may indicate that the company is not paying enough to attract and retain investors.
By paying attention to payout ratios, you can avoid getting stuck in a dividend stock that is headed for trouble or one that doesn’t have much room for growth.
Read More: Factors to Consider When Investing in Dividend Stocks
3. Investing in stocks recommended by others without doing research
There are a lot of investing strategies out there, and it can be tough to know which one is right for you. At the same time, there’s no shortage of people willing to give their opinion on which stocks are worth investing in.
While it can be tempting to just invest in the stocks your friend or neighbor recommends, it’s essential to do your own research before making any decisions. After all, nobody knows your financial goals better than you do. Blindly following someone else’s recommendations can lead to some serious consequences down the road.
So take the time to learn about dividend stocks and make sure they fit into your overall investment strategy. Only then should you start investing in them.
4. Not considering total return
When it comes to investing in dividend stocks, many investors focus solely on the income they will receive from dividends. However, while dividends can provide a valuable income stream, they are only one part of the equation. In order to make money from dividend stocks, investors need to focus on total return, which is the combination of dividends and capital gains.
For example, let’s say you buy a stock for $100 that pays a $5 dividend. Over the course of a year, the stock price rises to $105. Your total return would be 10%, which includes a 5% dividend yield and a 5% capital gain.
Now let’s say you buy a similar stock paying a $5 dividend at the same price of $100. But with this one, the stock price falls to $95 in the course of the year. Your returns will include a 5% dividend yield and a 5% capital loss leaving you with a total return of 0.
As this example shows, overlooking total return can lead to missing out on profits. If you invest in a company that pays a high yield but is a generally poor business, it becomes a zero-sum game where you gain a dividend but lose on price appreciation.
So, when it comes to investing in dividend stocks, make sure you look into your potential total return to avoid this grave dividend investing mistake.
5. Not reinvesting dividends
Many investors choose dividend stocks for the steady income stream they provide. But if you’re not reinvesting those dividends, you’re missing out on a critical opportunity to grow your wealth.
Dividend reinvestment is when you use the cash dividends you receive from owning shares in a company to purchase additional shares of stock. This has the effect of compounding your returns, as you’ll not only earn dividends on the original shares you purchased but also on any new shares that were purchased with reinvested dividends.
For example, let’s say you own 100 shares of a dividend stock that pays $2 per share annually. If you don’t reinvest those dividends, you’ll receive $200 in cash each year. However, if you reinvest those dividends to purchase additional shares, you’ll not only receive $200 in cash, but you’ll also get additional dividend payments on the new shares you purchased.
Reinvesting your dividends can help you build wealth over time and reach your financial goals sooner. So, if you’re not currently reinvesting your dividends, start doing so today. It’s one of the smartest things you can do as a dividend investor.
- Read More: What Happens When Interest Rates Rise?
6. Not diversifying
One of the most significant dividend investing mistakes you can make is not diversifying. Diversification is important because it helps to reduce risk. When you invest in a single stock, you are putting all of your eggs in one basket. If that company goes bankrupt, your investment will be worthless. However, if you invest in a portfolio of stocks, then you will still be able to make money even if one or two of those companies go bankrupt.
Many people make the mistake of thinking that they can pick winning stocks by themselves and that they don’t need to diversify. However, this is a dangerous way to think. No one can predict the future, and even the best stock pickers will have losing investments from time to time. By diversifying, you can help to protect yourself from big losses.
