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Many different investment strategies exist and each one comes with pros and cons. For example, a growth investment strategy focuses on finding companies that are expected to grow at an above-average rate compared to other stocks. This strategy can lead to higher returns, but there are potential drawbacks, too.
"Growth stocks offer high returns but are risky, making careful research [of] a company’s fundamentals and competitiveness key," Simon Chandler writes for Business Insider.
Value investing takes a different approach. Instead of targeting companies that appear to be growing quickly, it involves buying securities that appear underpriced. The benefit may not be as immediate as a growth stock, but an article by James Royal for Bankrate claims, "[E]vidence suggests that value stocks outperform over time."
And then there are dividend-focused strategies. Dividend investing involves buying stocks from companies that regularly distribute a portion of their earnings to shareholders as dividends. This strategy provides investors with an ongoing income stream as well as the potential for capital appreciation over time. It’s distinct from growth investing, which targets companies expected to grow rapidly, and value investing, which targets undervalued stocks.
"For many investors, regular dividend income is a solid, safe way to grow a nest egg," Bob Sullivan writes for Forbes. "An investing strategy built on dividend income can be an important part of any saver’s portfolio, especially as a source of cash flow when it’s time to turn lifelong investments into a retirement paycheck."
Dividend investing is appealing as it can provide a steady flow of income. But, it’s not right for every situation — and you have to weigh the tradeoffs with this unique strategy. Here’s what you need to know about dividend investing before you dive into it.
The pros of dividend investing
Dividend investing offers several attractive advantages. First, it offers a steady income stream since shareholders receive profits quarterly or at least once a year, according to Stephen A. Abraham of Investopedia. This one aspect alone might make dividend investing an attractive strategy for those in retirement or anyone else who needs consistent income.
Second, dividends can feel reassuring. No matter the state of the market, there’s comfort in knowing that you’re going to receive a tangible return on investment regularly.
Third, dividend investments may be a bit more predictable and stable than others. Writing for The Motley Fool, Jason Hall says, "Because of their lower volatility, dividend stocks often appeal to investors looking for lower-risk investments, especially those in or nearing retirement." Of course, this isn’t always a guarantee, as each company and industry is different.
Lastly, dividends can be reinvested, which can lead to compounded growth over time as you buy more shares. It’s like a snowball effect — the more you have, the more you can earn.
The cons of dividend investing
Despite the appealing advantages, it’s also essential to understand the downsides of a dividend investing strategy.
One notable drawback is tax implications — particularly for high-earners. While dividends can provide a nice income stream, you will pay taxes on that income whether you need it or not. And depending on the type of dividends, ordinary or qualified, you could pay taxes at your highest marginal tax rate.
There’s less flexibility with a dividend strategy because there’s no way to dial it up or down. Your portfolio will generate taxable income every quarter regardless of how much you actually need.
"Another potential downside to investing in dividend-paying stocks is that companies that pay dividends are not usually high-growth leaders," Abraham adds. An investment strategy centered on dividends might cause you to overlook young, up-and-coming companies that reinvest their profits instead of paying them out as dividends. These reinvested profits might fuel future growth and, potentially, higher stock prices. A lack of diversification in this way will often come back to bite you.
Another point to consider is dividend safety. "Dividends are not guaranteed and sometimes companies are forced to cut them or eliminate them entirely due to financial difficulty," Brian Baker writes for Bankrate. So, relying on dividends for income can carry a risk if those payments are reduced or eliminated.
Is a dividend strategy right for you?
Different investing strategies work well for different situations, and there is no one-size-fits-all approach. Depending on your financial goals, risk tolerance, investment horizon and other personal circumstances, one strategy may be more suitable for you than another.
In the end, it all boils down to your personal financial journey and the specific goals you’ve set for yourself. Before investing, consider seeking a certified financial planner’s advice to determine if a dividend investing strategy is right for you. Smart investing is about making choices that support your financial goals, backed by academically sound, expert advice.
TrueNorth Wealth is here to help. Ranked among the top wealth management firms in Utah and Idaho with offices in Salt Lake, Logan, St. George and Boise, TrueNorth Wealth is your gateway to building lasting wealth while finding joy in your financial journey. Their exceptional team is dedicated to empowering families across Utah and helping them achieve true financial freedom and flexibility.
To schedule an appointment, call 801-274-1820 or visit truenorthwealth.com.
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