Myths & facts about dividend investing

Most investors look for low-risk, high-reward investment strategies, and a popular choice is dividend investing. Dividend investing involves investing in stocks and funds that pay investors dividends, offering them a regular source of income.

Dividend investing is often promoted as the safest stock market investment avenue, offering high returns. However, we must recognise that no investment strategy is 100% ideal.

To make informed financial choices, objectively identifying the positives and negatives of dividend investing is crucial. In this blog, we help you do so by busting some of the biggest myths associated with dividend investing.

Myth #1: Dividend investing is boring

• Many people believe dividend investing is boring because dividend stocks are often associated with slow-growing companies.

Reality:

• It can be boring if you look at high-yield stocks only. But, if you look at low-yield stocks, too, it can be exciting because of the considerable growth potential.
• Low-yield dividend stocks can offer capital appreciation and higher payouts, making them more dynamic than they first appear.

Myth #2: Dividend investing is tax-efficient

• Investors often assume that dividend payouts are always taxed at rates lower than those of other investments.

Reality:

• Dividends are taxed at the same rate as long-term capital gains.
• Dividend investing is more tax-efficient than other investment options like bonds, but non-dividend stocks aren’t too far behind.
• The total returns from dividend stocks are lower than the returns from non-dividend stocks. Consequently, the net income you receive from dividend stocks might not always be higher and can sometimes be lower than from non-dividend stocks.

Myth #3: High-yield stocks are the best

• It is commonly believed that stocks with the highest dividend yields are the best investment choices.

Reality:

• Dividends are paid from a company’s cash flow. So, a higher dividend payout reduces a company’s cash flow, leaving less money for business growth and expansion.
• High-yield stock companies typically reinvest a lower percentage of their profits into the business, which can indicate that the company’s management does not see significant growth potential.

Myth #4: Dividend investing is the safest choice

• Many investors assume that dividend investing is the safest and most reliable strategy.

Reality:

• Dividend investing is relatively safer and more reliable. However, not all dividend investment options can be considered entirely safe.
• If a company gives regular dividend payouts, it indicates the company’s strong financial health. However, there is no guarantee of future stability.
• Dividend stocks operate within the stock market and are affected by its volatility. For example, General Electric reduced its dividends for the first time in 70 years in 2009 due to the recession.
• In some cases, companies even borrow money to maintain dividends, which creates hidden risks for investors.

Myth #5: Dividend investing offers good diversification

• Many new investors enter the stock market by investing in dividend stocks, as they are relatively low risk and help with portfolio diversification.

Reality:

• Dividend stocks do add variety and can reduce risk, but they are not sufficient on their own.
• Relying only on dividend stocks means missing out on non-dividend opportunities that may offer higher growth.
• Ideal diversification comes from a balanced mix of dividend and non-dividend investments.

10 Tips for dividend stock investing

Dividend investing is a popular strategy for building wealth and generating passive income. The following 10 tips can help you get started and make smarter investment decisions. 

1. Understand the definition of dividend stocks
   • Dividend stocks pay out a portion of a company’s profits to shareholders.
   • Unlike growth stocks, they offer regular income along with potential price appreciation.
   • Knowing this difference helps you set the right expectations.
2. Look for dividend growth, not just yield
   • Companies that steadily increase dividends show financial strength and stability.
   • A very high dividend yield can sometimes be a warning sign.
   • Dividend growth is often more reliable than stocks with the highest yield.
3. Check the payout ratio
   • The payout ratio shows the percentage of earnings paid as dividends.
   • A healthy payout ratio is usually below 60%.
   • A lower ratio indicates that the company has enough profits to reinvest and sustain payouts.
4. Diversify your dividend portfolio
   • Do not allocate all your money into one sector or company.
   • Spread investments across industries like utilities, healthcare, technology, and consumer goods.
   • Diversification reduces risk and ensures a steady income stream.
5. Reinvest dividends through DRIPs
   • A Dividend Reinvestment Plan (DRIP) automatically reinvests dividends into more shares.
   • This helps to grow wealth through the power of compounding.
   • It’s a simple way to grow your holdings without extra effort.
6. Consider Dividend Aristocrats
   • The Dividend Aristocrats is a stock market index comprising companies that have increased dividends for over 25 years. 
   • They tend to be financially strong and reliable.
   • Adding them to your portfolio can bring long-term stability and steady income.
7. Evaluate the company’s financial health
   • Assess the company’s fundamentals apart from studying the dividend itself. 
   • Consider key factors like cash flow, debt levels, revenue growth, and profitability. 
   • A strong balance sheet increases the chances of consistent dividends.
8. Think long-term
   • Dividend investing isn’t a strategy for the short-term; it requires patience. 
   • Holding quality dividend stocks for years enables you to maximize compounding benefits.
   • Long-term investors benefit from increasing payouts and capital appreciation.
9. Keep taxes in mind
   • Dividends are taxable as regular income or capital gains. 
   • Knowing the tax rules enables you to calculate actual returns and choose the right accounts.
   • You are liable to pay taxes on dividend income at applicable slab rates. But if the dividend payout exceeds Rs. 10,000, then the company deducts a Tax Deductible at Source (TDS) at 10% as per Section 194. 
10. Monitor and review regularly
    • Dividend investing doesn’t mean that you set and forget. 
    • Review companies periodically to ensure dividends remain sustainable.
    • If a company cuts dividends or shows financial weakness, consider rebalancing.

Dividend stock investing gives maximum results when approached with discipline and patience. You can create a reliable income stream and earn wealth in the long term by focusing on dividend growth, diversification, and financial strength. The objective is to build a portfolio that supports your financial goals and not just earn high yields. 

Conclusion

While dividend investing is an excellent source of passive income, it is wise to be mindful of its associated risks. Understanding the myths surrounding dividend investing and replacing those myths with reality is essential to making intelligent investment choices.

Need help investing your money? Turn to Tata Capital Wealth. Our team of financial experts evaluates your risk and helps you pick the best investment plans to achieve your financial objectives. 

Visit the Tata Capital Wealth website to explore various instruments and power up your investment journey today!