According to research group Finder, approximately 12 million people in the UK currently have no savings. That’s up from 10.5 million a year ago. What’s more, close to 50% of the population have less than £1,000 in the bank. But by leveraging the power of dividend stocks, it doesn’t have to stay that way.
The cost of buying and selling shares has drastically fallen over the last decade. As such, it’s possible to start building up an asset base with as little as £100. It’s tempting to start chasing small-cap penny stocks hoping to stumble upon an explosive winner. However, in most cases, this is just pure speculation that rarely ends well, especially for newer investors.
Therefore, while it’s not as exciting, focusing on boring but reliable income stocks is the more prudent way to start building wealth, in my opinion. It often carries significantly less risk. And that can be a handy advantage when first starting out on an investment journey.
How do dividend stocks work?
While it’s often forgotten, shareholders are actually owners of a business. Whenever an investor buys shares, they’re purchasing an equity stake in a company. And that grants them a claim on any earnings.
For younger enterprises, the management team usually retains any profits to reinvest internally and grow operations. However, for established industry titans with fewer meaningful opportunities for expansion, excess earnings end up accumulating as cash which is then redistributed to the owners (the shareholders) via a dividend.
In other words, by holding shares of an income stock, an investor will receive dividend payments, usually every three months.
However, it’s important to stress that dividends are funded by profits. If a company’s bottom line starts to shrink from internal or external disruptions, shareholder payouts could end up on the chopping block. In extreme cases, they could disappear entirely.
So, while dividend stocks are usually mature industry leaders, that doesn’t mean the risk level is zero.
Investing from scratch
Looking at the UK’s flagship stock market index, the FTSE 100, British dividend stocks typically pay an average yield of around 4%. Meaning that for every £100 invested at this rate, an investor can expect to earn £4 a year from dividends.
However, by being more selective, achieving yields closer to 6% is entirely possible without taking on too much additional risk. And providing that investors buy exclusively high-quality enterprises that can grow shareholder payouts, this dividend yield can rise substantially over several years.
For example, Safestore, a self-storage real estate business, has grown its dividends by more than 400% in the last decade. And shareholders reaped even more rewards since the stock price increased by roughly 585% over the same period.
Combined, Safestore investors have enjoyed an estimated total annualised return of 23.4% in the last 10 years. At this rate, a £100 investment in 2013 is now worth roughly £820. But for those who decided to invest £100 each month, they’re now sitting on nearly £41,000!
Dividend stocks may not grow rapidly overnight. But given enough time, they can establish significant wealth even with modest sums of capital.
