In an article published earlier this month, I explained how I invest the money within my Stocks and Shares ISA. To recap, I invest around 60% of my capital in FTSE dividend stocks (with a strong focus on companies growing their dividends) and the remaining 40% in growth companies listed both in the UK and internationally.
Here, I’ll look at some of the reasons why I invest the majority of my ISA money in dividend stocks.
The first reason is I like the passive income they provide. With dividend stocks, I get paid a second income stream for doing absolutely nothing, irrespective of what the stock market is doing. My ultimate goal is to build an income stream from dividend stocks (tax-free within the ISA) that I can retire on.
Next, I enjoy the financial flexibility dividends provide. When I receive a cash dividend it gives me options. I can spend the cash if I want to, or I can reinvest it. Currently, I reinvest all my dividends. However, it’s nice to know that if I needed some extra cash flow for some reason, I could turn to my dividend income.
More certain returns
I also like the fact dividend payments are quite a reliable source of investment returns (although they’re not guaranteed). Compared to capital gains, which are highly uncertain, there’s more certainty of a return. In finance, this is known as the ‘bird in the hand’ theory (i.e. a bird in the hand is worth two in the bush).
Two sources of profit
Another benefit of dividend stocks is that they provide me with two potential ways to profit – from the dividends received and also from capital gains. This is particularly advantageous when stock prices are falling. Dividends also take a lot of the stress out of investing as you can profit without having to constantly buy and sell.
Research also suggests dividend-paying companies (particularly those that consistently increase their dividends) tend to generate excellent returns over time. For example, a study by analysts at Ned Davis Research found that between 31 January 1972 and 31 December 2018, dividend-paying companies in the S&P 500 index outperformed non-dividend-paying companies by a wide margin.
I’ll also point out that dividends stocks enable me to take advantage of one of the most powerful forces in investing – compounding. By reinvesting my dividends, I can buy more shares which, in turn, gets me more dividends for the future.
Finally, dividend stocks tend to be less volatile than growth stocks, as dividend-payers are generally well-established companies that have strong balance sheets and reliable cash flows and profits. This, in theory, means my portfolio is likely to fall less during a bear market, which provides peace of mind.
Overall, there are many advantages to investing in dividend stocks. In my overview, it’s a simple, yet effective, way of investing for the future.
Views expressed 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.