How to Invest in Dividend-Paying Stocks: A Beginner’s Guide
This article was reviewed by Robin Hartill, CFP®.
Would you be interested in an investment that provided passive income on a regular basis and also had the potential to increase in value over time?
If this type of investment sounds appealing, you may want to consider investing in stocks that pay dividends. Curious? Here’s a guide to help you figure out whether dividend-paying stocks could be right for you and how start investing for beginners.
What Is a Dividend?
A dividend is a portion of a company’s earnings that’s distributed back to shareholders. A company’s board of directors votes on whether to approve a dividend.
Not all stocks pay a dividend. They’re more common in large companies with a steady history of earning profits. You’re less likely to get a dividend when you buy stock in a newer company, because they often need to reinvest their profits to grow.
Dividends are usually paid out quarterly and can be paid in cash, stock or property. Cash dividends are most common, so we’ll focus on those in this post.
Who Might Want to Invest in Dividend-Paying Stock?
Because they provide income, dividend-paying stock is particularly attractive to those living on a fixed income, particularly retirees on a budget. This group can use the cash dividends that a stock pays to help cover living expenses, while keeping the original stock investment intact.
But retirees aren’t the only investors interested in dividend-paying stock. Younger investors may want to reinvest the cash dividend back into more shares of the stock. A company that offers a dividend reinvestment plan, or DRIP, allows investors to do so automatically.
This practice can then result in greater future dividends for the investor since he or she owns more shares of the stock. Over time, the compounding effect benefits the saver.
How to Choose Stocks That Pay Dividends
There’s no shortage of dividend-paying stocks to choose from. More than 400 of the 500 companies on the S&P 500 pay a dividend. With all those options available, how should an investor choose?
One thing to look at is the dividend yield. That’s the ratio of the annual dollar value of dividends paid out per share to the share price. For example, say a stock is priced at $25 and pays total annual dividends of $1. The stock’s dividend yield is 4%.
While it’s natural to want stocks that pay the highest dividend, another strategy is to consider stocks that have most consistently paid a dividend. This strategy is especially useful for long-term investors who want to make sure the stocks in their portfolios provide steady fixed income year after year.
These investors will want to pay attention to the Dividend Aristocrat list, made up of S&P 500 companies that have:
1. Paid a dividend in each of the last 25 years
2. Increased the dividend in every one of those years
The list is updated each year, and the 2020 edition lists 66 companies. It includes huge names such as McDonald’s, Wal-Mart, and Coca-Cola.
How to Buy Dividend-Paying Stocks
You can buy individual shares of dividend-paying stocks the same way you buy any stock using your brokerage account. But buying individual shares is not the only route to take.
Investing in a dividend mutual fund or ETF can help you diversify your portfolio by spreading your investment across a number of different stocks. They can also help you keep brokerage fees to a minimum. You’ll have to buy a dividend mutual fund directly through the mutual fund company, but you can buy dividend ETFs the same way you buy stocks.
While we’re not going to recommend specific stocks, mutual funds or ETFs, you could start by checking out some of the dividend-specific mutual funds or ETFs at low-cost brokerages, like Vanguard or Schwab.
Should You Buy Dividend-Paying Stock?
Investing in stocks is inherently risky, and dividend-paying stocks are no exception. There’s no guarantee that any stock will increase in value or that the company will continue to pay a dividend. But dividend-paying stocks tend to be somewhat conservative since the issuing company is typically well-established. They’re less risky than buying stock in an up-and-coming company, but they usually lack the huge potential for growth.
For an investment with a guaranteed return, you will need to turn to something like a certificate of deposit (CD) or money market account. Investing in bonds is also less risky than investing in stocks.
But remember: Some risk is necessary if you want your money to grow. For most investors, dividend-paying stocks are a good way to achieve long-term, steady growth.
Julie Mayfield is a freelance writer and blogger specializing in personal finance and lifestyle topics. She is the creator of two blogs: The Family CEO and Creating This Life. Senior editor Robin Hartill, CFP®, contributed to this report.