Dividend funds might automatically seem like the best investment that you can make due to their higher-than-average payout. But are they worth it? Should you put your money into dividend funds?
Dividend funds can be a good investment if the right companies are chosen. However, focusing only on the dividend number can be dangerous. And if you overlook a company’s performance and just focus on its dividend, then you might lose your investment value.
Read on if you want to learn precisely how you can leverage dividend funds, and how to avoid the common pitfalls of investing for dividends.
Why Should You Invest in Dividend Stocks?
The question concerning dividend stocks is a highly debated one in the investing world.
On the one hand, dividend stocks are outstanding because they allow you to earn passive income and reinvest more into your stocks. On the other hand, dividend stocks can be seen as unnecessarily risky, and many overlook the company and only evaluate the percentage of dividend yield.
If you don’t fall into this trap, dividend stocks can be a great addition to your portfolio. However, unlike real estate, they open you into the world of passive income at any price range, which otherwise requires a lot of money.
However, if you overlook a company’s performance and just focus on its dividend, then be prepared to lose all of your money. Think about it this way: If a company is offering a 10% dividend, then it’s going to have much less money to grow.
A lack of growth means that the company will struggle to keep up with the markets. Then, the share price will fall, your dividend yield will drop, and your income will fall.
To avoid this trap, make sure that you do both technical and fundamental analysis of the companies you consider investing in. This can save you so much heartbreak in the future and isn’t very time-consuming at all.
You want to see a reasonable PE ratio, strong leadership, and growing profit margins. Ultimately, if you believe in the company, then invest.
Hence, dividend funds – which in essence are a diversified portfolio of dividend stocks – shouldn’t be the most significant part of your portfolio. They’re a great addition but not the star of the show. This is because individual stocks are extremely risky, and when investing, the aim is to lower your risk as much as possible.
There are ways to diversify high-dividend stocks, which we’ll discuss later.
Pros and Cons of Dividend Funds
It’s good to consider the pros and cons of any investment before you put your capital at risk. So here are some pros and cons of dividend funds.
- The quickest way to passive income. Many people invest their money in order to be able to retire early and live off of their investments. Dividend funds are the quickest way to a lot of passive income and just might get you to the early retirement of your dreams.
- Opportunity for reinvestment. Because of the higher payments, dividend funds give you a more significant opportunity for reinvestment. Instead of spending your dividend payments, you could reinvest them to receive more dividends. Eventually, this will spiral out of control, leaving you very wealthy.
- Higher risk: Investing in individual stocks is always going to be a risky choice. The company could go out of business, making you lose your capital, and you’ll lose all those dividend payments. Safer investments, such as index funds carry much less risk and are deemed by many experts as a better investment.
- Capital gains: Investing in dividend funds often means that you’ll have to forego substantial capital gains. Many strong dividend stocks, such as coca-cola, are very slow-growing, which means that you’ll likely be behind the market by some margin when you invest in dividend stocks.
Best Dividend Stocks To Consider Any Day
Good dividend stocks can be hard to come by. But here are some of the best that you can buy right now:
- Coca-cola: Coca-cola is a household name and has historically gone up in value very steadily. They offer a dividend of 3.15%, which is very respectable. Coca-cola is one of the safest dividend funds that you can invest in.
- Johnson and Johnson: Another household name, this company has kept up with the markets and steadily increased in value. Couple this with a dividend yield of 2.64%, and you’ve got yourself an excellent dividend stock.
- Target: This retail giant offers you a dividend of 90 cents per share. As you build up your portfolio, these dividends will add up, and you’ll be getting more passive income than you could imagine!
This is by no means an extensive list, and of course, changes in the market could cause a stock’s security to go into jeopardy. Therefore, it’s best to diversify your dividend stocks to reduce your risk.
Why Dividend Funds Are a Great Addition to Your Portfolio?
As we mentioned before, individual dividend stocks are a precarious way to invest your money, which casts doubt on the effectiveness of dividend stocks as a whole. But, what if there was a way to diversify dividend stocks quickly and easily? Would that solve the problems?
Well, there is, Some index fund brokers, such as Vanguard, that offer an index fund that focuses on dividend yield. For example, Vanguard’s fund offers a dividend of 2.79%.
This figure is higher than some of the best individual dividend stocks out there, which just cements that this is a great option. Your money is shared across just under 200 companies in a variety of sectors.
This significantly reduces your risk while still exposing you to a simply excellent dividend yield.
Vanguard’s dividend fund is an excellent choice for anyone who wants to get their feet wet when it comes to dividend investing. You’ll lower your risk but by no means damage your reward.
Dividend Funds Explained
You may be wondering, just what’s a dividend fund? Simply put, a dividend fund is a collection of stocks that pay a high dividend yield. A dividend is like a bit of reward that companies give their shareholders for investing in their company.
Typically, standard companies pay small dividends of around 1-2%, but some companies don’t even pay dividends at all. Dividend stocks, on the other hand, pay much higher dividend yields.
Typically, they range from 3-5%, but some do go higher.
An Alternative to Dividend Funds: REITs
If you can’t find a dividend fund that’s right for you, or you’re thinking about diversifying your portfolio, then you might want to consider buying a REIT over dividend funds.
But just what is a REIT?
It stands for “Real Estate Investment Trust.” Essentially, it’s a way to invest in real estate with minimal cash. Thousands of holders all raise money, and each takes a small percentage of the profits.
REIT founders are, by law, required to give out 90% of all profits to their shareholders, which allows for some pretty severe dividend yields. In fact, some REITs pay a dividend of up to 10%. REITs are in serious competition for dividend funds.
Of course, they come with their limitations, but they might be worth considering over the traditional dividend fund.
So, there’s your comprehensive guide on dividend funds. If you invest smartly and pick individual dividend stocks wisely, they can be a simply fantastic way to grow your money and build your wealth. However, if you invest just for the dividend, don’t expect to become rich over time.
Dividend funds, at least, partially solves this problem for dividend investors by offering diversification across numerous dividend paying securities.
Dividends are a great thing to have, but you should never base your decision solely on this figure. Live by this rule, and keep in mind that your capital is always at risk when you invest, and you should be successful in your journey.