Despite their ability to generate steady income, dividend stocks were largely ignored by individual investors for decades as they were considered to be old fashioned. During the tech boom of the late 1990s, they became even less popular, as traders were more interested in stocks that were rapidly rising in value. Following the global financial crisis, though, dividend stocks are back in favor, especially among investors who are interested in less-risky assets.
For most individuals, selecting dividend-paying stocks is a straightforward process. According to a report by David Ruff, Portfolio Manager of Forward Management, however, investors often make mistakes that may reduce their total return. In the analysis he discussed the following:
- Focusing on higher yields – On the surface, high-dividend yield stocks seem like the best place to put your money. This may not be the optimal idea, as previous research indicates that these types of stocks are unsustainable and companies that offer a smaller dividend tend to perform better.
- Giving weight to macro, rather than micro factors – By making generalizations about certain sectors or even large geographical locations, individual investors set themselves up to lose great investment opportunities. Factors like a region's unemployment rate should not be make or break.
- Ignoring growth factors – Dividend investors often forget that buying these stocks is not just a source of immediate income, but can provide funds for retirement as well. Investors should choose stocks that raise dividends and boost their earnings over time.
- Jumping on the bandwagon – Investors should avoid buying into a popular dividend-paying stock simply because it's popular. Engaging in this type of investing is risky because should there be a mass exit from the stock, the price could crash. Lesser-known dividend stocks can diversify your portfolio and may also result in higher growth.
- Limiting yourself to blue chips – These big-name corporations often seem like the best choice due to their stability. Because of their popularity, however, they can be prohibitively expensive. A wise alternative would be to invest in companies that are smaller, but familiar and have cheaper valuations.
- Relying on passive investment strategies – A conservative or passive strategy focuses more on dividend yield and less on the strength of a company or its sector. According to Ruff, active investors are better able to anticipate and respond to changes in an organization's dividend policy and make an informed decision about whether or not to withdraw their assets.
Dividend stocks have clear appeal, but investing in them is not without challenges. To minimize risk, consider using SmartStops' financial portfolio software.
Categories: Risk Management, Trading & Portfolio Strategies