Important Pros and Cons of Dividend Investing you must know!

Dividend investing have made thousands of people rich with passive income. But is buying dividend stocks really good for you?

As a small investor, you must have come across some big-time investing gurus that peach the massive benefits of buying dividend paying stocks.

They say things like, ‘how these bucket of dividend paying stocks have made them money even when they sleep, or giving them the opportunity to even leave their job’.

If owning a dividend stock give so much advantages, why isn’t everyone buying them?

Is there some secrets that they are trying to keep you in the dark?

In this article we shall dive in and find out the truth of dividend investing, and uncover the pros and cons of dividend investing that these investing gurus are not telling you.

But first, let’s get an rough idea on what is dividend investing.

Let’s go!

What Is Dividend Investing

Dividend investing, which is also called as ‘income investing’ is a strategy that focus on buying stocks that offers a sizable dividend that are usually paid quarterly, or half yearly by companies to their shareholders. Depending on the company’s dividend policy, dividend can be paid in the form of cash, shares or other properties.

Amount of dividend paid is depending on amount of shares you hold, and the amount of dividend per share to be distributed as decided by the company’s management.

For most companies that offers a stable dividend, they will offer you an option to automates your reinvesting of your dividend into the stocks, this is called DRIP.

(DRIP stands for ‘dividend reinvestment plan’ allows you to automatically reinvests all money earned from a dividend into the stock account.)

There are many types of dividends, but the following 2 are the most common:

Cash dividend is the most common type of dividend. Cash is paid to each shareholder according to the number of shares they hold and the amount declared by the company. Cash dividends are generally issued from the retained earnings of the company. The retained earnings of the company decrease when the cash dividend is issued. This can be found on the balance sheet.
Stock dividend is the next most common type of dividend. Each shareholder is given a specific amount of shares depending on the amount of share they hold. If the company issues less than 25 percent of the current number of outstanding shares, then it will be called a stock dividend. If the company issue more than 25 percent of the current number of outstanding shares, then it will be a stock split. The market value of the company does not change when a stock dividend is issued, or when a stock split occurs.

Companies that offer cash dividend is what most dividend investors are looking to invest.

Simply because

“Cash is King”

Till now, dividend investing sound like the way to invest, but what are exactly the pros and cons of such a investing strategy.

Let’s find out!

Pros of Dividend Investing

Build Passive Income

This is the most obvious and probably the main reason why people want to invest in dividend-paying stocks. Just by holding the stocks, you will get paid periodically without you lifting a finger.

For a lazy investor like me, this is simply the holy grail of passive income investing.

Resistant To Market Crash

Companies which are able to consistently pay dividend over a long period of time are mostly stable blue chip stocks.

Generally, these dividend paying stocks are less volatile where their share prices fluctuates less.

Which means, you won’t be getting a heart attack that often than investing in a penny stock, which means you get more sleep at night.

Getting Paid Even During The Bear Market

To be clear, during a bear market, your stock price will probably fall and your portfolio will fall in value.

But even during these stressful times, these dividend stock will probably still pay you a dividend. In some cases, the dividend will help offset the drop of the share prices.

Inflation Protection

During inflation, companies usually raise their prices on goods, which in turn sometimes raise the revenue of the company.

This will sometime have a positive effect on increasing the payout of dividend to shareholders like you and me.

Grow Your Portfolio

By paying you dividend, you will have cash to reinvest in different stocks, or simply reinvest back into the same stock if the price is right.

Some companies have Dividend Reinvestment Plan (DRIP) which allows you to easily grow your portfolio and make your investing as passive as possible.

Alternative Retirement Plan

When you reach your retirement, you will need money to spend. Going back to work at the age of retirement may not be a great way to spend your retirement.

Many people investing in dividend stock as a way to plan for their retirement, so that they will have money coming into their bank account, even when they stop working.

In fact, we have an article which teaches you, how to earn $50,000 passive income by investing in for retirement.

Two Ways To Cash Out

Dividend stocks allows you to cash out in 2 different ways;

Either by selling the stock after the price of the stock raises.
Or simply by doing nothing and waiting for the dividend to be paid to you.

It remove the headache of you to time the market on when to sell the stock for the profit. Talking about being a lazy investor.

Retain Ownership

When you brought an amazing stock at a low price, which you really like and have a huge potential of growth, the last thing you want is to sell that stock.

Dividend stocks allow you to cash out while retaining your ownership of the stock.

Cons Of Dividend Investing

Possible Unsustainable Dividend

A high dividend does not always mean that it is good. Sometimes the dividend paid is too high that it becomes unsustainable that costs the company growth.

Example:

Most people buy dividend stocks because of their fat dividends and will sell them when the dividend decreases.

While most companies pay their dividend through their retained earnings, some companies pay their dividend by borrowing from banks and financial institutes. Simply because, if they are unable to pay the dividend, their investors sell the stocks.

The move of borrowing to pay their shareholder’s dividends could be disastrous to the company’s future if they are unable to pay their dues.

Pay More Taxes

Taxes is a money-eating monster, but every citizen of the country should pay their taxes to help in country building. But getting taxed twice can be much more painful that you know.

Cash dividend paid by companies will get double taxed before it enters your pocket.

Dividend Double Taxation

First, the company pays the corporate taxes of 21% on its profits to the IRS.

Then, the investors (you) are taxed 20%, 15%, or 0% rate, (depending on your tax bracket) before the dividend enters the bank account. *Ouch*

Subjected To Policy Changes

As dividend payout is determined by the board of directors of the company. You will basically have no say in how much dividend will you get.

The dividend policy are totally up to the board of directors to decide. They can either, maintain, increase, decrease, or even to stop paying out dividend entirely.

Changes of these policy can cause the investors to sell their stock, which cause the stock price to fluctuates.

Read Also: Ways to profit from a Market Crash

Is Dividend Investing For You?

Dividend investing is an amazing strategy which allows you to earn a passive income. Dividend investing is great for most investors including the young and experienced investors. There are many benefits of dividend investing, but as a investor, we need to be aware of the risk as well.

Each investor have different risk appetite and investing style.

Dividend investing have many pros and cons which can impact our return on investment.

Pros of Dividend Investing:

Passive Income
Market Resistant

Getting Money Even at Bear Market
Inflation Protection
Grow Your Portfolio

Alternative Retirement Plan
2 Ways to Cash Out
Retain Ownership

Cons of Dividend Investing:

Unsustainable Dividend
Taxes

Policy Changes

Those listed in this article are some of the main benefits and risk of dividend investing.

Some like to build a passive income, while others like to make a quick money. An investing style which does well for someone might not be the same investing style that suites you.

There are many different investing style, such as; dividend investing, growth investing, value investing and even hybrid style investing.

The only way to know which investing style suits you more, is to read more.

Knowledge

Knowledge is what differentiate a successful investor from a gambler. Successful investors like Warren Buffet is successful, because he have the right knowledge to make the right decision to buy or sell a stock.

Warren Buffett read approx 500 pages a day.

Knowledge on investment can be learn from books or articles like this one. Reading can only make you wiser and smarter, so that you too maybe able to make the right decision in your investment.

“Education is a progressive discovery of our own ignorance.”
Will Durant

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Antony C.

Founder & Financial Writer at Income Buddies | Website | Posts by Author

Antony C. is a dividend investor with over 15+ years of investing experience. He’s also the book author of “Start Small, Dream Big“, certified PMP® holder and founder of IncomeBuddies.com (IB). At IB, he share his personal journey and expertise on growing passive income through dividend investing and building online business. Antony has been featured in global news outlet including Yahoo Finance, Nasdaq and Non Fiction Author Association (NFAA).