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Is investing in dividend stocks a good idea?

In the current low-interest-rate environment, in which savings accounts are paying minimal interest, many people are looking for new ways to boost their wealth. Dividend stocks, which often offer yields of 5% or higher, have become popular.

Is investing in dividend stocks a good idea though? Let’s take a look at some of the advantages and disadvantages of investing for dividends. 

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Advantages

Dividend stocks certainly offer investors many benefits.

For starters, with such shares, you have two potential sources of profit. You can profit from both the dividends you receive and any capital gains from rising share prices.

For example, consider the popular share GlaxoSmithKline. Over the last year, it’s paid a dividend of about 5%. However, its share price has also risen around 23%. That means that if you’d bought the shares one year ago, your total gain for the year would have been around 28%, which is a fantastic return.

Another advantage of these stocks is that they allow you to compound your investment returns, which is the key to building wealth. For example, had you taken your GlaxoSmithKline dividends and reinvested them, you’d receive more dividends in the future.

Additionally, investing in dividend stocks is a very easy way to build a passive income. When you own them, you get paid on a regular basis for doing absolutely nothing.

Finally, companies that pay dividends are generally well established businesses that have reliable earnings and financial strength. As a result, their share prices tend to be a bit less volatile than the share prices of growth companies during periods of stock market turbulence.

Disadvantages

Of course, like any investment, they have their disadvantages.

First, you can lose money if share prices fall. Unlike when you put your money in a savings account, your capital is at risk.

Second, the share prices of stocks fluctuate from day to day. This means that the value of your investment will rise and fall constantly. You need to be comfortable with these fluctuations.

Third, dividend stocks are a long-term investment. They’re not suitable for those who are saving for short-term goals.

5 dividend stock investing tips

If you’ve considered the advantages and disadvantages above, and concluded that investing in dividend stocks could be a good idea, here are some quick tips:

  • Focus on companies that are growing their dividends. Studies have shown that these companies tend to produce the highest total returns (dividends and capital appreciation) over time.

  • Dividend yield isn’t the only thing to focus on. A company with a lower yield that is growing its dividend payout at a fast pace could turn out to be a better investment than a company with a high yield, growing its payout at a slow pace. 

  • Be cautious with companies that have really high dividend yields (7%+). This can be a sign that the company is in trouble.

  • Always make sure you diversify your capital over many different companies. This will help reduce your risk.

  • If you’re not comfortable picking individual dividend stocks yourself, you could invest in a fund that pays dividends. 

In conclusion, investing in stocks can be a very effective way of building wealth over the long run. When you consider the low interest rates offered on savings accounts right now, I think investing in shares that pay dividends is a smart idea. 

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Edward Sheldon owns shares in GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. 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.