The Pros and Cons of Stock Dividend Income

Demographic trends point to an increasingly aging population. But what many older Americans are finding is that savings for retirement might not last as long as they live, especially as longevity rates are expected to increase.

The fear of running out of regular income when a person is in his or her 70’s or 80’s, for example, is very real. This trepidation has many rethinking their investment strategies to include a greater emphasis on stock dividend income.

The lure of receiving a regular, largely predictable, dividend check every quarter is gaining investor attention. For those no longer working, retired or not, cash flow is king.

Successful stock dividend investors look at the relationship between the share price and the dividend yield.

How to arrive at the dividend yield? Here’s an example.

Mr. Smith acquires stock for $10 a share.
The stock pays Mr. Smith a dividend of $0.10 per quarter. Thus, for every share Mr. Smith owns. he will you receive $0.40 per year.
Divide $0.40 by $10, equal 0.04.
Convert 0.04 into a percentage
Mr. Smith’s stock has a 4% dividend yield

If the dividend is not raised or lowered, the yield will rise when the price of the stock falls. It will fall when the price of the stock rises. Because dividend yields change relative to the stock price, it can often look unusually high for stocks that are falling in value quickly.

Here we examine the pros and cons of stock dividend investing.

On the plus side:

Many of the companies paying good dividends have a long history of stability and solid financial performance. It is not difficult for an investor to identify these firms and feel confident they will receive a predetermined return.
Dividend stock investing is a viable strategy for weathering a volatile market, especially for those with long-time horizons. For the risk averse, this is generally an easy choice.
Reinvesting regular payouts can be a great way to build significant returns.
Stock dividend investing has become a premier technique for retirement planning as it more or less guarantees a steady cash flow.

On the minus side:

During bull markets, income investors may feel short changed as their aggressive growth counterparts may substantially outperform.
There will be dividend stocks that cannot keep up their usual payouts during all economic environments. A good example: some companies in the travel and energy industries reduced or pulled their dividends during the recent pandemic crisis to lower expenses. Keep in mind a company is not legally obligated to maintain a set dividend.
Dividend investing is not as “passive” as some would lead you to believe. Investors are cautioned to do their homework and track the financial health of companies they plan to target. Don’t expect to simply sit back and tally your returns.
Be on the lookout for yield traps. Be suspicious of a firm’s unusually high yields, especially compared to other companies in the same sector or industry. This could signal a serious flaw in the company’s financials, so be wary. It is better to target dividend stocks with a lower yield but a very strong reputation for performance. It is more beneficial to zero in on dividend growth and a company’s likelihood of raising future dividends than to focus on current high yields.

Investors can build a protective net around their income investing strategy through diversification into a multitude of income investments including fixed income, preferred stock, real estate and certain types of insurance.

In addition, investors need not invest in income producing stock to the exclusion of all others. There are numerous growth stocks and others that are good investments even if they are not now producing regular income.

But as Warren Buffet once remarked, “If you don’t find a way to make money while you sleep, you will work until you die.”

The Pros and Cons of Stock Dividend Income

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