Why (& When) to Consider Dividend Stocks in Your Portfolio (2024)

FAQs

Should you have dividend stocks in your portfolio? ›

Dividend investing can be a great investment strategy. Dividend stocks have historically outperformed the S&P 500 with less volatility. That's because dividend stocks provide two sources of return: regular income from dividend payments and capital appreciation of the stock price.

No matter what stage of life you're in, dividend-paying stocks can be a great way to supplement your income and improve your portfolio's growth potential. Just be sure you research the companies' overall financial health, not just their dividend rates, before investing.

Stocks and mutual funds that distribute dividends are generally on sound financial ground, but not always. Stocks that pay dividends typically provide stability to a portfolio but may not outperform high-quality growth stocks.

Some stocks have higher yields, which may be very attractive to income investors. Under normal market conditions, a stock that offers a dividend yield greater than that of the U.S. 10-year Treasury yield is considered a high-yielding stock. As of April 26, 2024, the U.S. 10-year Treasury yield was 4.67%.

Overall, we believe creating a dividend portfolio with 20 to 60 stocks provides a reasonable balance between the need for diversification, a desire to keep trading activity low, and a limited amount of research time to devote to maintaining a portfolio.

“One mistake to avoid,” Cabacungan says, “is to buy a company's stock simply because it issues a high dividend.” If the company has leveraged excessive debt to fund the dividend, it could come at the expense of future profitability and hurt growth prospects.

The Procter & Gamble Company (NYSE:PG), AbbVie Inc (NYSE:ABBV), Colgate-Palmolive Company (NYSE:CL), and PepsiCo, Inc. (NASDAQ:PEP) are some of the best dividend growers to consider for retirement as these companies hold decades-long dividend growth streaks and have strong balance sheets.

Dividend stocks are an important contributor to your long-term gains, and dividend-paying stocks tend to expose you to less risk than non-dividend-payers. That's why the majority of your stocks should be dividend-payers at all times.

“Dividend capture strategy” returns are the trading technique of buying a stock just before the dividend is paid, holding it just long enough to collect the dividend, then selling it. If you can sell it for as much as you paid, you have “captured” the dividend at no cost, other than the transaction costs.

Why not invest in dividend stocks? ›

They offer relative stability, may pay increasing amounts over time and may provide steady income. But relying too heavily on dividend stocks as a primary investment approach could put you at risk and reduce your long-term investment gains.

In a market that generates a 2% annual yield, you would need to invest $600,000 up front in order to reliably generate $12,000 per year (or $1,000 per month) in dividend payments.

A dividend value trap occurs when a very high dividend yield attracts investors to a potentially troubled company. Not all companies that pay a high dividend yield are in trouble, but investors should question why a company is willing to pay out so much more than its peers.

In order to avoid a dividend trap, investors need to be skeptical and understand dividend yield more deeply. The ratio that is reflected in the dividend yield does illustrate how much profit one will get from investing in these stocks, but that should not be the only reason investors buy stocks.

To generate $5,000 per month in dividends, you would need a portfolio value of approximately $1 million invested in stocks with an average dividend yield of 5%. For example, Johnson & Johnson stock currently yields 2.7% annually. $1 million invested would generate about $27,000 per year or $2,250 per month.

Dividends are particularly valuable in retirement because they provide a consistent stream of income that can help cover living expenses. And, unlike bonds, dividend stocks offer the potential for capital gains as well as income. That means your portfolio can continue to grow even as you withdraw money from it.

Dividend Stocks are Always Safe

However, just because a company is producing dividends doesn't always make it a safe bet. Management can use the dividend to placate frustrated investors when the stock isn't moving. (In fact, many companies have been known to do this.)