Dividend growth investing is arguably one of the most widely applicable strategies if you want to achieve long-term goals at a lower risk. But regardless, you need to understand the game to play it well.
Because you’re not investing in managed funds and are entirely responsible for your investments, dividend growth investing requires knowledge.
The goal is to accumulate income that covers your expenses, even after you’re done working. To do so, there are several things to keep in mind. So, in this article, we will go over:
- Countering the unique (albeit relatively small) risks of dividend portfolios
- How to create a dividend portfolio, from picks to long-term strategy
How Do Dividend Yields Work? We’ll Help You to Understand
How do I create a dividend stock portfolio?
Dividend-paying stocks are a part of many investment strategies.
In this case, we are specifically trying to maximize dividend payouts as a form of income. So, there are a few things to consider before getting started.
1. Playing It Safe
What this means to you will depend on your unique investment attitudes and goals. So, you will start by creating your own criteria before considering specific investments. These criteria must include your rates and the financial health of the companies you’re investing in.
We can’t overstate the need to truly play it safe here. You’re getting into a long-term investment strategy where your choices need to be made more carefully.
As a rule of thumb, when in doubt, don’t buy. Wait and investigate your other options first. Missing one opportunity is always better than pulling the trigger too soon with dividend growth investing.
2. Requirements
The requirements you set are meant to ensure a level of portfolio safety to offset market risk and inflation. Let’s look into how you can accomplish this.
3. Balance Sheets
Balance sheets are public and provide the rawest, most useful look into the viability of your investments. One of the first things to look at is yields. You will want a bare minimum of 3%, but it’s wiser to set your threshold to 4%, 5%, or even higher if you want to invest more defensively.
At the same time, avoid the “yield trap”. High yields are a good sign, but they can easily muddy the waters when there are greater problems with a company. So, we must then look at other signs of underlying health.
Factors such as a company’s debts, valuation, and reserves must also be factored in if you want to ensure minimal risk.
Some companies may currently be unprofitable, but that doesn’t mean they are overvalued (they may in fact be undervalued).
Likewise, some companies with high yields may be a few bad years from serious financial challenges, which is unacceptable for you as a dividend growth investor. So, conversely, you also need to avoid the “value trap”. You cannot rest your strategy on just one or two metrics.
4 Practical Steps to Building a Proper Dividend Portfolio
To make a proper dividend growth portfolio, there are a few practical steps to follow.
1. Diversification
You want a diverse dividend portfolio of very healthy stocks. You are investing for your future needs, not for faster profits. Some people thoroughly understand their industries and can afford more risk and less diversity.
In your case, you’re just trying to maximize dividends over a long period.
A diverse portfolio includes stocks:
- Of only the highest underlying health
- With high average dividends
- In several different industries
- With high dividend stability
- With less risk of dividend cuts
The diversity of industries is very important. As recent history has shown, having 50% of your portfolio in oil can be excellent at one moment, but it starts to look extremely bad when oil prices plummet.
Industry-wide problems of another nature can also ruin your plans. More fundamentally, these kinds of failures in your dividend portfolio would render it antithetical to dividend growth investing as a concept.
2. Stability Over Growth
Having stable, long-term growth is great. But without stability, your portfolio is at risk of failing to produce the outcomes this strategy is meant to create.
A company’s long-term financial stability, especially when it comes to debt and credit rating, are always worth considering. You only want to hold onto companies that are stable, with strong credit and less current debt.
3. Dividend Trends
This is another key to this strategy’s success. Companies with a history of rising dividends are better choices for this strategy.
Understanding the leadership of the company and their attitudes towards dividend investors are of course helpful. But a longer history of progressively increasing dividend payouts is ideal.
4. Reinvest Dividends
Unless your financial goals are going to be met very soon, you need to continue to think long-term. So, use a large portion of your dividend payouts to re-invest into your dividend portfolio.
What Are The Risks That Must Be Accounted For?
While dividend growth investing is relatively safe (when you don’t cut corners or ignore your parameters), there are two risks you will need to consider:
- Market risk
- Inflation
Market risk is present in all stock investing strategies. Inflation, on the other hand, can cut your profits and postpone the attainment of your goals. Both of these risks are ever-present when investing, but the damage depends on your portfolio’s specifics.
To create a good income that isn’t defeated by these risks, you will need to:
- Account for inflation while accounting for your profits
- Adjust for what you pay in taxes
- Account for losses incurred due to market risk, wherever applicable
Conclusions on Dividend Portfolio Growth
Growing a successful dividend growth portfolio requires caution, patience, and long-term thinking.
Maximizing dividend payouts is key, but not at the expense of companies’ financial stability. To avoid risk, investors can diversify their portfolios, set strict criteria for stock picks, and reinvest earnings to create ever-growing levels of wealth for long-term financial goals.
Photo by Francesco Gallarotti on Unsplash