In today’s economy, it is crucial that every person have a couple of income streams other than their full-time job (if you have one). Holding down a job is not going to make you rich and certainly won’t help you become financially independent. Most jobs are not as secure as they once were which is why it is so important to take control of your financial future.
Creating A Passive Income Stream
One way to earn extra money is by creating passive income streams. Passive income streams are nice because they require little of your time once they are up and running. Arguably the best way to create passive income is from earning dividend income. If built properly, dividend paying stocks can provide steady income and the opportunity to build wealth, unlike your job.
There is no doubt that earning dividend income provides many benefits to shareholders of stocks. However, just because a company pays a dividend does not mean it is a good investment. Below is a list of stock tips that investors should think about before building their portfolio.
10 Tips for Dividend Investors
Building a solid portfolio of income producing stocks takes time and patience but can definitely pay off over time. Here are 10 tips (or D’s of dividend investing) that every dividend investor should consider when entering the market.
- Dividend Growth Over Dividend Yield – One of the most tempting things to new dividend investors are high yielding stocks. Many of the highest yielding stocks are made up of income trusts or companies ready to make a dividend cut, similar to what the banks experienced a few years ago. Instead of focusing only on dividend yield, investors should be looking at dividend growth. A company that continues to increase its dividend by 10% every year with a low yield is much better than investing in an unstable company with a current 10% yield.
- Dividend History – Most of the time, the past is no prediction of the future. However, when it comes to the top dividend paying stocks, a company’s dividend history can give investors some hints about the future. The dividend aristocrats index, published by Standard and Poor’s each year is a good place to start. The index only includes companies that have consistently raised their dividends for at least the past 25 year’s annually.
- Don’t Overpay for Dividend Stocks – There are growth stocks and then there are blue chip dividend stocks. Investors should never overpay for a dividend stock. Even the best investments go on clearance every once in a while. Dividend stocks are no different and investors should never overpay to own them. Using the price-to-earnings ratio and future price-to-earnings calculations are good ways to tell if a stock is too expensive or not.
- Dollar Cost Averaging – Dollar cost averaging (DCA) is a good technique to use for any long term portfolio. The idea is to make equal purchases of a stock that are spread out over a couple months (or years). This prevents an investor from overpaying for a stock and helps bring an investment to actual market levels. Anyone in a company sponsored retirement plan is probably already dollar cost averaging their investment. Every time you contribute money from your check to your 401k, you are using this technique.
- Diversify – Every investor has probably heard analysts talk about diversification. It is important to own stocks from different sectors in order to limit exposure to one particular industry. Diversification is probably even more important to a dividend investor.
- Dividend Payout Ratio – We already know that dividend history and yield are important measures of income stocks. Dividend investors must also pay attention to the dividend payout ratio of a company as well. A company who continually increases their dividend each year could be a great investment opportunity. However, if the dividend increases are coming at the expense of earnings, then there could be a problem. The payout ratio will tell investors how much of a company’s earnings are being used to pay the dividend to common shareholders.
- Direct Stock Purchase Plans – Direct stock purchase plans (DSPP) are great for new investors with little capital to start their portfolio. A DSPP can be setup with many large corporations where the investor buys stock directly from the company they are investing in. This eliminates the need for a stock broker and usually any commissions that are charged to buy stocks. Most direct stock purchase plans also allow investors to invest small amounts of money every month from an automated transfer from their bank. You don’t need a lot of money to start investing through one of these plans.
- Dividend Reinvestment Plans – A dividend reinvestment plan (DRIP) can provide a great opportunity to start dollar cost averaging in your portfolio. Either through your broker or directly through the company you are investing in, you can setup a DRIP which automatically reinvests dividends into more shares of stock. These plans are automated, don’t charge commissions, and can help investors build wealth.
- Discipline – Having discipline is important for all investors no matter what type of investment strategy they use. Dividend investors are no different to this stock tip. If you believed every rumor or the hype you hear on the news or internet, you would probably be tempted to buy stocks that are overpriced and sell ones in your portfolio that you shouldn’t. Educate yourself, develop a trading strategy, and stick to it.
- Dividend Cut – When a company decides to cut its dividend, it may be time to sell. Many successful dividend investors use this as their number one rule for selling a stock. While it is not always full proof, a dividend investor should be building a portfolio of companies that are growing their distributions, not cutting them. Even if you don’t decide to sell a stock after a dividend cut, make sure you have an exit strategy.
Investing in solid blue chip dividend paying companies is one of the best forms of passive income. Not only do investors get recurring income streams every quarter or month, they also have the opportunity to build wealth if the company’s stock price rises. Contrary to what many new investors think, starting a dividend stock portfolio does not take a lot of money upfront but can be an important step to building personal wealth.