If you’ve been planning to construct your own dividend portfolio but haven’t got around to it yet, 2019 could be the perfect year to start. Many high-quality FTSE 100 dividend stocks have been sold off in 2018, and that means there are some eye-catching yields on offer right now.
However, investing for dividends is not as easy as it sounds. I began building my own personal dividend portfolio around five years ago, and while I’ve made progress, it hasn’t always been plain sailing. With that in mind, here’s what you need to know before you start constructing a dividend portfolio.
High yields can get you into trouble
One of the most important things to be aware of when investing for dividends is that high yields can spell trouble. Often, the reason that a stock has a high yield is that a number of investors have already sold the shares because they think a dividend cut is likely, and this has pushed its yield up. You may think that a yield of 7% or 8% is fantastic, however, if you’re hit with a dividend cut you may suffer capital losses, as more investors dump the stock upon news of the reduced payout.
Higher yields are also often associated with low or negative growth companies. These kinds of companies can also see their share prices decline over time as earnings fall. So in the interest of generating healthy total returns (dividends plus capital appreciation), it can pay to be cautious towards higher-yielding stocks. If a yield looks too good to be true, then it probably is.
Dividend growth is key
One of the most important things to focus on when investing for dividends, in my view, is dividend growth. Often, the best performing dividend stocks over the long run are the companies that have consistently lifted their dividend payouts over the years. The reason behind this is that a rising dividend tends to place upward pressure on the company’s share price over time, so investors benefit from the fantastic combination of both increased income, and capital gains.
My advice here: don’t rule out a company that’s only yielding 3% or so if it is growing its dividend strongly. If a company is yielding 3% and lifting its payout 15% per year, in five years your yield could be over 6%, and there’s a good chance you’ll have generated some capital growth too.
You’ll need patience and discipline
Lastly, if you’re investing for dividends, be prepared to have considerable patience. Dividend investing is very much a long-term, slow-burn investment strategy. You’re not going to get rich overnight and in reality, it will probably take a few years before the compounding effects of your dividend reinvestment strategy kick in and you begin seeing good results.
Investors should also be aware that dividend stocks, as a whole, can underperform the market at times, particularly if value investing is out of favour. So, there will be periods where dividend investing can be a little frustrating.
However, with patience and discipline, dividend investing can be an extremely effective strategy. Over a period of 20 or 30 years, the strategy is capable of generating life-changing wealth, as all the dividends that have been reinvested over the years work to generate more dividends. Therefore, the sooner you start building your dividend portfolio, the better.
