Many people view dividend stocks as a safe investment, making them the most appealing option for beginner investors. However, can you actually lose money with these stocks? You must know the answer before you dive in.
You can lose money with dividend stocks, although they’re still less risky than other types of investing. With dividend stocks, you can lose money due to share prices going down, investment return being less than inflation, tax rate increases, and the company cutting dividend yields.
If you want to learn more about the risks of dividend stocks, make sure to continue reading. There’s a lot to watch out for, but staying informed will help you make the best financial decisions. Here’s everything that you need to know!
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Risks Associated With Dividend Investing
There are risks associated with dividend investing, despite it being the safer option in most cases. These are the four main ways that you could potentially lose some money while investing in dividends:
- Share prices go down.
- Investment return doesn’t keep up with inflation.
- There are high tax rates associated with the yield.
- The company cuts or removes dividend yields.
While there are some risks to dividend investing, there are more positives. For instance, they offer a reliable way to earn a passive income. However, due to these possible risks, you’ll want to make sure you always keep an eye on your dividends for potential problems in the future.
This helpful YouTube video breaks down the risks of dividend investing in terms for beginners:
I’ll be breaking these risks down further below.
1. Share Prices Go Down
There’s always the possibility of share prices going down, whether the business makes dividend payments. If you notice share prices dropping, you might want to think about selling your shares. That way, you won’t have to eat the cost if the company goes under.
Keep in mind that it’s natural for share prices to drop by the amount of each dividend payment after the ex-dividend date. This occurrence happens to show that new investors won’t receive dividends.
You don’t want to sell when that happens. Instead, keep your eye open for signs that the trading volumes are below average, which could indicate the business isn’t doing well financially.
You may not want to rush into a sale since dividend stocks tend to do best when you hold them for the long term.
2. Investment Return Doesn’t Keep Up With Inflation
Inflation is a serious issue. Not investing in shares that keep up with inflation means you’re losing money. Over time, the money you saved in the stock is worth less than when you put it in.
You might want to make sure that your overall return (dividend yield + stock appreciation) is high enough to stay above inflation levels.
You can check current inflation rates at the U.S. Inflation Calculator. It’s always a smart plan to check in each year and do your best to stay above the inflation rate with your investments. This resource also allows you to check historical inflation rates and check the differences between the two years. It’s great for investors to use often.
3. There are High Tax Rates Associated With the Yield
You’ll also need to make sure you’re not paying all of your dividends away in taxes. Tax dividend rates can change and rise at any time, so make sure you’re familiar with the tax laws in your area.
If the rates are too high, the company might discontinue its dividends. These taxes can impact businesses and investors, so make sure to keep that in mind.
4. The Company Cuts Or Removes Dividend Yields
Companies can also cut back on their dividends at any time, or even eliminate them. You’d lose out on your passive income if that were to happen. However, many established businesses constantly strive to offer better yields each year.
Businesses don’t need to pay dividends to their shareholders legally, nor do they technically need to increase the yield.
Companies can easily cut back on dividends without going into default, making it a possibility at any time. It’s more likely to happen when the company redirects its cash flow or struggles with debts.
When dividends are an essential part of your passive income, missing out on payments can feel like a significant loss of money.
Dividend Investing Mistakes That Cost You Money
There are also several mistakes that dividend investors can make, which are usually very costly learning experiences. You’ll want to be aware of these errors, so you can avoid them and respond efficiently when issues do arise. They include:
- Always chasing high dividend yields.
- Not considering the dividend payout ratios.
- Not paying attention to the earnings growth.
Beginners can benefit from reading Stock Market Investing For Beginners on Amazon.com. This book covers all of the information you need to know, helping you avoid making the same mistakes that other beginners make.
Let’s now talk in detail about these errors.
1. Always Chasing High Dividend Yields
High dividend yields are desirable to all investors, but these options are scarce because they aren’t sustainable for a company. When you find high-yield stock, it’s essential to realize that they come with higher levels of risk.
When a yield is high for a long time, you can expect it to drop significantly at some point. These higher yields become too expensive for companies to pay out, especially when more and more people buy into them.
Of course, you want high yield returns in your portfolios, but you must realize that some ratios are too good to stick around. That being said, you can still make money off the yield until it starts declining.
2. Not Considering the Dividend Payout Ratios
You could lose money if you don’t consider the dividend payout ratio when you invest.
Investopedia defines the dividend payout ratio as “… the ratio of the total amount of dividends paid out to shareholders relative to the company’s net income.”
Essentially, this is a proportion expressing earnings paid to all shareholders, which is shown as a percentage.
Why do you need to check the payout ratios? Well, if the company pays out all its dividends now, there’s nothing left to make future payments. Additionally, there’s no money left for the company when the economy does poorly.
As a general rule, payout ratios that go above 80% are very risky for future dividends.
Fifty percent is usually safe, while 30% or lower isn’t as good for income. You’ll want to find a payout ratio that suits you and doesn’t harm the company’s finances.
3. Not Paying Attention to the Earnings Growth
If you’re ignoring earnings growth, you won’t have insight into how the company’s doing financially, so you want to pay attention so you know which businesses tend to gain in value.
You’ll need to check how a brand grows, as people tend to only choose well-established companies for dividend investing.
While this is a safe method, you could make more money over time by choosing the company that shows signs of rapid growth. They may offer better dividend payments later on and make you a higher income overall.
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Conclusion
While dividend stocks are usually the safest option for investing, you should always be aware of the risks. You want to consider inflation, taxes, and the possibility of the company cutting dividends before you decide to invest.
Overall, you’re still not as at risk, especially when compared to other investment strategies. As long as you take your time to consider all of your options first and make a plan, you should do very well!
Dividend shares are a constant and passive source of money for many investors today, who use them to diversify their portfolios.
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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