As readers of our Motley Fool Stock Advisor reviews will know, the newsletter is one of the most recommended sources of long-term investing advice, featuring high-growth stocks ideal for extended investment time horizons.
One of the suggested investments for sustainable returns is dividend stocks, which provide engagement in stock markets, consistent returns, and lower risk than many alternatives.
How Do Dividend Stocks Work?
Dividend stocks are investments in companies that pay regular dividends to their shareholders, with an established track record and solid market presence. These investment companies are mature, meaning that stocks are less likely to grow significantly in value, but there is a far greater potential for ongoing dividend payouts.
Investors can choose between two categories of dividend stocks: high-dividend stocks or dividend growth stocks.
The former are stocks that already produce high dividends paid to shareholders but may not necessarily increase the dividend rate in the future. Growth stocks, in contrast, have a strong potential for larger increases in future dividends.
Unlike the comparable benefits of investing in penny stocks, which have high volatility and short investment timespans, dividend stocks provide passive income characterized by regular payments distributed from company profits over a longer period.
Advantages of Dividend Stock Investment
The primary benefit of dividend stocks is the lack of risk. While every investment has some level of risk exposure or capital at risk, a high-dividend stock won’t suddenly lose value even if markets move downward, providing a relatively high level of safety when compared to other categories of growth stocks.
During negative market downturns, dividend stocks can appreciate, offering reliable capital protection and acting as a diversification component to balance out an investment portfolio. Value appreciation means that investors receive both regular payouts in the form of dividends and the potential to resell the investment stocks in the future to make an additional return.
The nature of dividend stocks means that they work passively, without commanding ongoing tracking and monitoring, so they are best suited to investors with a buy-and-hold approach or long-term investment horizon.
Dividend Stocks and Inflation
Inflation can influence the value and returns of many investment assets, but dividend stocks can act as a hedge to offset the impacts of inflation on an investment portfolio because of the natural progression where dividends increase in line with company growth. When prices and interest rates rise, dividends usually increase accordingly, sometimes to higher levels than inflation, which can counteract negative side-effects of inflation elsewhere in a portfolio.
However, investors must put sufficient time and energy into researching stocks and comparing potential investments before they select a dividend stock. Risks are generally lower, but there are disadvantages to consider. The main drawback is that dividend stocks tend to be focused on a limited number of market sectors and industries, so any overexposure in one area could have hidden pitfalls.
Diversification is essential to avoid unbalancing a portfolio by adding a number of dividend stocks that are all exposed to the same sector pressures. Companies may also change their dividend policies, affecting investor returns either temporarily or until they sell their stocks.