Individuals approaching retirement are often told to invest heavily in dividend stocks. This is because dividend stocks pay dividends, which adds to your passive income. Unfortunately, however, dividend stocks do not always perform as promised.
Here is what you should know before adding more dividend stocks to your investment portfolio.
How Do Dividend Stocks Generate Passive Income?
Dividend stocks are stocks offered by companies that regularly pay dividends to shareholders. Most dividend stocks come from large, well-established companies that pay dividends on a scheduled frequency.
For example, Walmart (WMT) and Unilever (UL) both make quarterly dividend payments. The stock prices of these companies also tend to remain relatively stable due to their size. Thus, while you may not experience a significant return on investment, you can enjoy steady, regular income from the dividend payments.
What Is the Average Return on Dividend Stocks?
The average return on a dividend stock depends on two factors – the underlying value of the stock and the dividend yield. Most dividend stocks come from companies with historically stable stock prices, which helps protect against a volatile market.
The dividend yield is used to estimate how much you may earn in dividend payments. Dividend stocks come from companies that tend to pay higher yields compared to the average.
For example, the average dividend yield for stocks on the S&P 500 is just under 2%. Therefore, a yield of 2% to 6% is considered good for a dividend stock, as it beats the average yield.
If you invest $1,000 in a dividend stock with a 6% yield, you earn $60 per year in dividends. Thus, you can generate more passive income by investing a sizable portion of your portfolio in dividend stocks.
What Is the Risk of Investing in Dividend Stocks?
Unfortunately, investing in any stock comes with risk. A high yield does not always result in a good investment. If the stock price decreases, the size of your portfolio decreases.
For example, after investing $1,000 in a dividend stock, the stock price decreases 20%, resulting in a $200 loss. You still receive dividend payments, but the value of your investment has declined.
Keep in mind that dividend stocks are not the only source of passive income. For example, fixed-income investments like US securities and corporate bonds offer fixed interest payments and less volatile price fluctuations. So instead of putting all your money into dividend stocks, spread your investments across multiple income streams.
How to Find Good Dividend Stocks for 2022
Comparing dividend yields can help you select suitable investments. Start by looking for companies with high yields, which are often found in the following sectors:
- Real estate investment trusts (REITs)
- Utilities
- Telecommunication
- Health care
- Energy
After finding potential dividend stocks to invest in, compare the yields to the average yield of the S&P 500. The S&P 500 includes many of the companies with the highest yields, making it a useful benchmark.
You should also compare dividend stocks to US treasuries. The average yield for 10-year US treasuries is around 1.54%.
Yet, you also need to consider the volatility of the stock. Analyze the stock price across different timeframes, such as the past month, past year, and decade. Companies with slow, steady growth and a long track record are likely to offer less risk.
In the end, dividend stocks can be as good as promised and a suitable source for passive income during retirement. First, however, you need to take the time to select the right stocks and continue to assess your portfolio.
Investing in a variety of dividend stocks in different sectors can help diversify your portfolio and reduce risk. However, you still need to monitor your portfolio for signs of trouble, such as falling stock prices.
