But first, what are dividends?
When you purchase a stock in a company you become a part-owner of the business, and dividends are your share of the profits. However, not all companies pay out dividends. While there are many pros and cons to purchasing dividend stocks, the decision to purchase these comes down to your personal investment goals.
Dividend stocks don’t suit all investors. Investors who are prioritising long-term wealth accumulation may want to focus on capital gains rather than on dividends. However, if you want to see results from your hard-earned money sooner rather than later, you may want to consider dividend paying stocks as part of your investment portfolio.
Dividends can be used as a form of income investing. Some people invest to grow their wealth, others are saving for retirement and then there are those who are looking for an additional income stream. If you are interested in investing for income, there are a few options that could be worth exploring but it is key to understand why you are choosing this path to invest. What will the extra income be used for and how does this form your strategy?
Fortunately, many ASX-listed stocks offer dividends to their shareholders, which are typically paid biannually. So, while finding a dividend-paying stock is generally straightforward, the difficulty lies in deciding on one to invest in. The amount shareholders receive as a dividend is directly linked to the earnings of the company – when earnings fall, generally so do the dividends. So, it’s important to consider the fundamentals of a company before you invest.
So, should you reinvest you dividends?
Financial Author and commentator, Noel Whittaker shares his insights on how to approach dividends and how they can be used to bolster your portfolio.
“I am a great believer in dividend reinvestment because it supercharges the compounding effect. For example, the All Ordinaries Index over the long term has averaged about 5% growth and 4% income. The difference in the numbers long term is massive.”
“As an example, let’s assume you are aged 30 and have been bequeathed $100,000 in somebody’s will. You invest that money in a share portfolio that produces 5% growth and 4% income over the long term. If you spent the income and just relied on the growth, the portfolio would be worth $552,000 when you turned 65. However, if you invested the 4% income as well, the total return would be 9% per annum and the portfolio would be worth $2.1 million on your 65th birthday. This is a great example of the huge effect that the rate of return makes on the end result over a long period.”
When it comes to dividends, it pays to be clear on what you’re trying to achieve in your investments and to stay on course. And remember, to consider your own personal circumstances, goals and appetite for risk before making an investment decision.
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