While making a million from the stock market often leads investors to take high risks on growth stocks, focusing on dividend shares could be a better idea.
Certainly, they may lack the excitement and potential to make high returns in a short space of time that some growth shares offer. But over the long term, they may provide the most realistic means of generating a seven-figure portfolio.
A company’s dividend policy says a lot about its current performance, as well as its future outlook. A business that is paying a generous dividend, and that plans to raise it at a fast pace in future, may have a management team that is optimistic about its future prospects, as well as its financial standing.
This could make the company more appealing to a range of investors. Over time, it may lead to a premium valuation, as investors price in a rising and dependable income stream.
Although dividend-paying stocks are often more mature businesses that do not have the same reinvestment opportunities as growth stocks, they could allow an investor to capitalise on the cyclicality of the stock market.
Dividends that are paid during bear markets could be used to invest in companies that trade on low valuations. This may enable an investor to maximise their long-term returns through buying low and selling high. And with the potential impact of compounding over a sustained time period, a large proportion of a stock’s total returns could come from the reinvestment of dividends.
While the FTSE 100 may have experienced a decade-long bull market that has seen its price level double, the index still offers a yield of over 4%. This is partly because it started the current bull run from a low ebb, and also because it has experienced a volatile period over the last year.
As a result, now could be a good time to buy a range of high-yield shares that offer improving dividend prospects. There is currently a wide range of choice, with a number of industries offering viable options for income-seeking investors. Buying shares in a range of sectors could reduce overall risk, and produce a more sustainable return over the long run.
Clearly, all investors would like to be able to pick the right growth stocks at the right time in order to generate exceptional returns. However, doing so on a consistent basis is highly challenging, and time intensive.
Therefore, for investors who have a long-term view and who are risk-averse, buying income stocks and reinvesting their dividends could offer the best opportunity to generate high returns over the long term. While it may take time for them to generate a seven-figure portfolio, consistent buying and reinvesting during opportune moments, such as that offered today in the FTSE 100, could lead to a seven-figure ISA in the long run.
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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.