Companies distribute a part of their profits to a class of their shareholders. The distribution may be in the form of cash or additional stock. Dividend stocks are companies that pay their shareholders regularly and are a source of income for the holders.
Here we discuss five top misconceptions about dividend stocks.
- Dividend stocks carry no risk: Equity investment inherently carries risk. When you invest in any company, whether they pay dividends or not, you are undertaking some level of risk. Even though dividend-paying stocks may appear risk-free as they make regular payments, there is always some uncertainty involved. You cannot assume that the scrip will always do well.
- Stocks with higher dividend yields are better: Online investing platform has made buying and selling equity very simple. Researching stocks has also become easy; when picking stocks, you may assume that stocks with high dividend yields are essentially better than stocks with low dividend yields. However, this is not accurate.
Example: ABC corporation offers a 10% dividend yield on their shares, which have a market price of Rs. 500; thus, their payout is Rs 50. XYZ corporation offers a 7% dividend on shares, the market value of which is Rs. 1000. Their payout is Rs 70. Thus, a higher yield does not necessarily mean a bigger dividend payout. Company ABC has a higher yield, but its lower market value may indicate a not so positive outlook for the company’s future. Thus, there is a possibility that the company may stop paying dividends in the future. Do not choose stocks only based on their dividend yield.
- Dividend stocks provide adequate diversification: Another misconception about dividend stocks is that investing in them offers enough portfolio diversification. Globally, almost 53% of small-cap companies pay dividends. If you focus only on the dividend stocks, you will exclude almost half the companies from your portfolio. With online stock investing, you have the opportunity to diversify not within sectors but across different countries too. Do not limit your options due to this misconception.
- Dividend-paying stocks outperform the market: Generalisations are best avoided when investing in stocks. Often, investors assume that dividend-paying stocks perform better than growth stocks. This is not true, and the converse is also not true. It is advisable to evaluate each company based on its unique aspects. A study conducted from 1991 to 2012 revealed that average annual returns on dividend stocks globally were 9.1 %, the same as the market returns. Growth stocks had average returns of 11.1%, but they exhibited greater volatility.
- Dividend stocks are an alternative to fixed income products: Even though dividend stocks pay regularly, they are not an alternative to fixed income products like bonds or debentures. If you want to have fixed income products in your portfolio, you need to look beyond dividend stocks. The dividends on stocks may vary depending on the company policy and performance.
Dividend-paying stocks can be an effective addition to your portfolio. They can be a source of regular passive income for all demographic groups. Avoiding misconceptions when choosing dividend stocks can help you make the right choice. Online stock investingallows you to pick from a wide range of options and research well also. So, make the best of this opportunity!