Every week there is at least one article on the internet recommending dividend paying stocks. This could also apply to dividend paying ETFs or mutual funds. But the articles never mention the challenges with buying dividend paying stocks for profitable investing.
There are many advantages to buying stocks or funds that pay dividends. And there are an equal number of challenges or consequences.
The benefits are obvious, or at least they appear to be obvious.
• Dividends are like earning interest
• High Dividends will beat inflation
• The number of shares of your investment grows as dividends are automatically re-invested in the stock or fund
So what are the challenges? The benefits sound very enticing.
Here are some of the challenges, some of the potential pitfalls:
• Holding period – in order to actually benefit from the dividends you must hold the stock for a mid to long term. Most stocks pay dividends every three months. Funds and ETFs generally pay only annually. So if you want to reap the dividends you need to hold onto your position. This means if the stock drops, the market goes into a tailspin, you must hold on if you want to get the dividend.
• Downward price movements can wipe out the value of the dividend.
• Selling a dividend producing position when you need cash can negate the dividend benefit.
So, is buying dividend positions a good idea? How can they fit in your portfolio?
The guiding principle should be one of diversification. In other words if you use investment software and your portfolio is based upon different trading strategies, different groups for profitable investing, then only one group should be based upon dividend paying symbols.
If you have eight positions in your portfolio, limit dividend payers to just one or two investments. Personally, I limit myself to just one high-dividend paying stock.
There are a few ways to form a group of dividend paying stocks, funds, or ETFs.
• Scan on your stock broker’s website. Fidelity Investments, for example, will let you search for stocks that have paid dividends and are large companies.
• Use the Standard and Poor (S&P) website to scan and select stocks that have paid dividends over xx% for at least xx years.
I created a group of high-dividend paying stocks that have a long track record of never missing a dividend payout. While these are not buy & hold type positions they are definitely more long term buys.
This chart illustrates some of the results since 2005 for a few of my trading strategies based on my high-dividend stocks. Note that my trading strategies include a market exit signal that had me sell during major market drops like the Great Recession of 2008.