Ideally, every investor should have a diverse portfolio. The portfolio should include stocks, bonds, index funds, real estate investment funds, and money market instruments. Young investors often don’t begin with a large account size, consequently they can only use the limited cash to invest in fewer options. So, when it comes to purchasing dividend stocks, are they really a good option for young investors?
Dividend stocks are good for young investors looking for safer but modest long-term returns on their investments. Those aiming for swift and substantial returns through share price appreciation should consider growth stocks. However, the latter is riskier due to inherent volatility.
Young investors must hold dividend stocks for years to earn a sufficient income. This may or maynot be the best strategy given one’s investment goals and risk appetite. Therefore, to further understand the pros and cons of trading dividend stocks from the viewpoint of young investors, read on!
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Why Are Dividend Stocks Appropriate For Young Investors?
Generally, dividend stocks are issued by established companies.
Almost two dozen companies on the S&P 500 have been paying an increasing annual dividend for about 50 years. S&P Global has paid dividends every year in the last 85 years. Interestingly, Buffett’s Berkshire Hathaway doesn’t pay a dividend, but it sure has invested in numerous dividend paying stocks.
Below are reasons why young investors should consider dividend stocks.
Dividend Stocks Are Less Volatile Than Growth Stocks
Blue-chip stocks are amongst the most stable investment options in the entire spectrum.
A company’s shares don’t get classified as blue-chip stock unless there’s a longstanding history of financial stability. Naturally, blue-chip stocks are expected to be less volatile, and they’re indeed so.
Considering the typical volatility in stock markets, including bullish and bearish phases, and not forgetting the financial crashes, blue-chip companies or dividend stocks are pleasantly stable.
Dividend Stocks Are Relatively Safe
Large corporations have precious assets, including but not limited to real estate, patented technologies, intellectual property rights, and trademarked products. Some blue-chip companies operate in niches such as oil and conventional energy that are hard to break into for startups.
Companies issuing dividend stocks have a strong balance sheet.
Besides, a company can’t keep paying dividends for years if it’s incurring losses. Dividends are paid from a profit or surplus cash reserve. Given their legacy and continuing performance, they are a safe option compared to growth stocks.
Dividend Stocks Have Predictable Returns
Verizon, Chevron, and AbbVie have consistently awarded dividends of 4.5% up to 5% in recent years. AT&T and many other blue-chip stocks have a predictable dividend yield.
Although the industry average may hover around 2% to 2.5%, some companies outperform others. Young investors can secure a safe and predictable passive income with such dividend stocks.
Disadvantages of Dividend Stocks
Dividend stocks are a preferred investment option among older investors.
Young investors usually aim for generous returns in a short span to grow their capital and subsequently diversify the investment portfolio. Besides, most young investors don’t start with a sizable account size to generate handsome dividends, and most dividends are a low yield of the share value.
Below are more details on why young investors may not want to invest in dividend stocks.
Dividend Stocks Only Give Modest Return
The 2% to 2.5% dividend on stocks is a modest return at best. Even when the dividend is as much as 5%, it’s not remotely near what a growth stock may offer in a short span, probably 12 months or so.
Dividend stocks provide a predictable and safe yet modest return.
Growth stocks promise an exceptional return if the company expands swiftly. However, the unavoidable volatility of growth stocks also makes them a high-risk option. Not all young investors can afford to hedge risks that wipe off a significant portion of their initial capital.
Dividend Stocks Have Low or Nominal Growth
Dividend stocks are predictable in their growth.
Blue-chip companies tend to have a saturated market share. There’s little to no room for expansion or venturing into new domains. This means that these companies’ surplus cash isn’t invested anywhere but passed on to the investors as dividends.
The values of many dividend stocks, such as AT&T, have remained largely unmoved for years. Chevron has a slightly different recent past, as it acquired Noble Energy, which boosted its growth as well as the share value.
Dividend stocks may also lose value in time if a company struggles to hold onto its market share.
Dividend Stocks Need Large Investments To Produce Higher Return
Young investors can grow their funds in two ways.
The first option is to add more capital through other sources of income, but this is difficult to achieve with dividend stocks. Meanwhile, the second option involves using the return on investment and having a larger fund, which means that the capital-intensive nature encourages young investors to consider growth stocks.
Taking the average of 2% return on investment as a dividend in a year, young investors will need $50,000 invested in such stocks to earn $1,000.
On the flip side, a young investor with a stock of Tesla would have made more than 6 times their investment between 2020 and 2021.
Tesla’s share price was below $100 until 2019. A young investor could’ve purchased 10 shares for $1,000. The same investment would’ve been worth nearly $9,000 in 2020/21 when Tesla shares peaked.
Young Investors Won’t Get the Best Returns With Dividend Stocks
Growth stocks don’t pay any dividends. Young investors can buy such stocks, hold per the circumstances and exit strategy, then sell the shares for a net return on investment.
However, the scenario is slightly different in the case of dividend stocks.
Investors earn an income every year when a dividend is issued, and there may be an exit strategy five years into the future. The average 2% annual dividend leads to around 10% return on investment as income over this period.
However, if the share price depreciates by 10% or more during the same period, the investor will have a net-zero return at the exit time.
Older investors try to hold as many shares as possible for a steady passive income, as they don’t always have a short-term exit strategy because the objective is to keep the stock.
Young investors looking for ways to increase their capital and then expand the portfolio will need exit strategies. The key is to secure the maximum returns given the limited resources in a desirably short period.
Dividend Stocks Aren’t Immune to Market Risks
Deutsche Bank, Nokia, and Lehman Brothers, among other blue-chip stocks, have crashed in the past. Dividend stocks aren’t invulnerable, as the share prices are subject to public perception and market analyses.
If a dividend stock can’t sustain the yield percentage and its balance sheet grows weaker, a substantial number of shareholders may choose to exit, leading to a crash.
All stocks have some degree of volatility.
Dividend stocks are more predictable and reliable than growth stocks because of how blue-chip companies function. Startups and other companies aiming for ambitious growth reinvest all their earnings, and chances are high they’ll incur a net loss for years.
Hence, their volatility is much greater.
Neither growth nor dividend stocks are a state of permanence. Microsoft was a growth stock until the early-2000s when it started issuing dividends, mainly due to market saturation. The tech giant started to grow again in the mid-2010s with new products and cloud-based services.
Microsoft continues to be a dividend stock, albeit with a low yield.
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Conclusion
Young investors should assess their risk appetite based on the available capital, understanding of different stocks, and short-term financial goals. Exit strategies are essential for most investments, especially stocks. Testing both dividend and growth stocks with moderate exposure may be a practical option for many.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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