How to start investing in dividend paying stocks
Over the last few months I’ve received a number of emails from readers on this question: how do I start investing in dividend paying stocks?
Today’s post will begin to provide some answers on that subject and hopefully give you some things to think about as well.
Wouldn’t you love to own a company (or companies) without ever having to spend a day at the office? It can happen and does happen for many investors. Owning stocks can be a great wealth building tool. Stocks can also destroy your portfolio if you are not wise about your decision(s), you are not diversified, and you let your emotions run a muck when buying or selling stocks. A stock represents a stake on a company’s assets and earnings. As you acquire more stock, your ownership or stake in the company becomes greater. This can be a very good thing – just Google Warren Buffett and read up on that guy.
Dividend Paying Stocks 101
You might already know from reading my site a company’s assets and earnings can be managed in many ways:
- Management can decide to reinvest earnings and grow the business.
- Management can decide to buy back shares so each remaining share can earn a higher proportion of profits.
- Management can decide to pay down debt.
- Management can decide to pay some of their earnings to shareholders in the form of dividends.
Many people, including myself, invest in dividend paying stocks for the expectation to get paid from the company’s earnings, so they/I can decide to reinvest the dividends to purchase additional shares of stock or do something else with the money. For example, when money makes money, that money can be reinvested to make more money. Companies that pay a consistent dividend are typically demonstrating good financial health although dividends from companies are never guaranteed. Dividends from companies can be increased (good), dividends can be paid at the same rate (OK), dividends can be cut (can be good and not so good) or dividends can eliminated all together (can be great and very bad). All this to say; companies that generate consistent (and rising) cash flow are probably good companies to own because there is the expectation you’ll be rewarded as a shareholder.
Is there a list of those companies available to pick from? Yes! Lists are published all over the internet everyday! However there are three places where you could start looking. Remember I said start looking not blindly buying.
Hunting Dividend Paying Stocks
Source # 1 – Consider owning what the big dividend mutual funds own
I posted this article on my site some time ago and it remains relevant. Check it out.
Source # 2 – Consider owning dividend “aristocrats”
Aristocrats is a broad term referring to a certain, higher standard of social class. This term has been associated with some stocks as it relates to their consistency and longevity paying dividends to shareholders.
A quick “Google” will show you both Canadian and U.S. stock aristocrats.
The keen readers out there will notice the U.S. “aristocrat” criterion is different than the Canada one. Off the top, only a few companies in Canada have raised their dividend every year for multiple decades, equitable to U.S. aristocrat status:
- Fortis (FTS)
- Canadian Utilities (CU)
In fact, Fortis raised their dividend late last year and Canadian Utilities raised their dividend earlier this month. Companies like Canadian Western Bank (CWB) and many others have been consistently raising their dividends for 10, 15, and 20 years.
Now, do all stocks labelled as “aristocrats” make for great long-term investments?
I don’t know. Honestly, I don’t know. I do know based on the histories of these companies they have been good dividend payers in the past so in hindsight, the investors that expected to get paid, did. Remember what I said above: companies that pay a consistent dividend are typically demonstrating good financial health although dividends are never guaranteed. Past performance is never indicative of future results. You know this if you’re a Toronto Maple Leafs fan! Kidding aside, the future is always cloudy including the financial one and picking individual stocks make your investing risks higher.
Source # 3 – Consider owning what the big Exchange Traded Funds (ETFs) own
When I look at XIC, VCN and a few other big name ETFs that cover the broad Canadian equity market I see these holdings consistently in the top-10 or top-20 year after year:
- Canadian banks and insurance companies (financials).
- Canadian railways (industrials).
- Canadian telecommunications companies (telecommunications).
- Canadian energy companies (energy).
Think Monopoly, the game, for Canadian investing: banks, railways, energy and utilities.
When I look at VTI (or VUN, it’s Canadian cousin), where VTI is a massive ETF that covers thousands of U.S. stocks, I see these holdings at the time of writing this post in VTI’s top-10:
- Exxon Mobil
- Johnson & Johnson
- Wells Fargo
- Berkshire Hathaway (Warren Buffett’s company)
- General Electric
- Procter & Gamble
- JPMorgan Chase
You may recall Apple just started paying a dividend but Berkshire does not and likely never will based on their shareholder policy. Again, a company’s assets and earnings can be managed in many ways.
How to start investing…
To buy and build your dividend paying stock war chest I suggest you open a self-directed Tax Free Savings Account (TFSA) and/or a self-directed Registered Retirement Savings Plan (RRSP). Self-directed accounts like these allow you to buy a number of different assets actually not just individual dividend paying stocks. You can hold cash, bonds, ETFs and more.
This way, if you decide to invest in indexed funds later, you can. There is more on indexing in a bit.
I’m focusing on these accounts for you today since I think investors are wise to maximize their registered accounts, like these ones, before investing in a non-registered, taxable account. I mean, why pay taxes on investments if you don’t have to?
- TFSA = no tax deduction with after-tax contributions, and tax-free dividend income from investments. You can read more here.
- RRSP = claim tax deduction for account contributions, and tax-deferred dividend income until withdrawals occur. You can read more here.
For what it’s worth I try to buy my dividend paying stocks when they are close to 52-week price lows AND I have enough money to invest in the first place. Those are just a few of my criteria. The latter is not easy (saving up the money) and the former watching stock prices takes time and effort. On that note this is just one reason why indexing is so great. You don’t need to watch the stock market or try and hunt for deals. My friend Preet Banerjee put it best:
Preet is very smart guy so you should listen to him.
Which brings me back to this…should you invest in dividend paying stocks?
That’s your decision.
Are there risks? Absolutely.
Could you underperform the market as a dividend investor? For sure.
Could you outperform the market as a dividend investor? Maybe but the odds are against you.
Are there benefits of getting paid to be a shareholder? Yes. It will be nice to (eventually) own some companies and never go to work. But you can diligently save and invest using indexed products and get to the same retirement promised land, maybe faster and with less risk by indexing. In the end only you can decide (potentially with your trusted financial advisor) if investing in dividend paying stocks is right for you. There is much more to the stock investing process than what I wrote above. Hopefully today’s post provided some how-to information for you to get started and things to consider.
What’s your take on investing in dividend paying stocks? Are you an indexer instead? Do you have a hybrid approach like me? Share your story in a comment.