Published on June 30th, 2017
This is a guest contribution by Irena Mckenzie. Irena Mckenzie is a Castle Hill local and is a very experienced local, mobile bookkeeper and successful small business owner. She has many years experience in all facets of bookkeeping and office work. She has run various small businesses for many years and understands exactly what it takes to get a small business up and running at full speed.
Dividend investing is a sophisticated strategy which, if employed well, can provide substantial benefits to dedicated investors. However, failure to use this strategy appropriately can be a recipe for disaster.
To make sure the strategy works properly for you, here are some of the most common mistakes to avoid. Also included are brief notes on how to reduce or eliminate the impact of these potential pitfalls.
Mistake #1: Seeking dividends in the wrong places
As a potential problem in dividend investing, this issue is the most glaring. Many people want to invest for dividends, but focus on the wrong sectors or stocks to reach their objectives.
For instance, people often pile into big-name firms including tech stocks, which tend to be far more focused on growth than regular dividend payments to investors. People see these companies pay a few large dividends and assume they are maturing, changing from a growth- to dividend stage firms, but that’s typically not the case.
Tech companies often require significant periodic capital investments that can disrupt, delay, or devoid investor dividends. The nature of their industry also leaves these companies more prone to mergers and acquisitions, which are both capital intensive and highly speculative – both of which represent risks to the reliability of future dividend payments.
Investors who want to investor for dividends first need to do extensive research on which sectors and companies are appropriate for this strategy. While the landscape is always changing, there are typically a few tried-and-true companies that have long-been used for employing various dividend-focused strategies. If you want to get the best results from this strategy, it’s your job to make sure you’re giving it the best execution.
Mistake #2: Not investing in companies with growing dividend yields
When considering a particular investment, the most common number that investors consider first is stock price. Sadly, this number taken alone is almost entirely irrelevant in a dividend strategy. Instead, investors need to focus in on dividend yield.
The first thing you look at shouldn’t be a chart of the stock price, but a map of the company’s historical dividend payments. Make sure that these figures are consistent, reliable, and hopefully increasing. Your aim is not to identify companies with rising stock prices – that comes into play with growth strategies, but less so with dividend investing. Instead, you want to find companies that are making regular, consistent payments to investors.
Note: The Dividend Aristocrats list is an excellent place to look for just such businesses.
Mistake #3: Not reinvesting dividend payments when possible
Often, when using a dividend strategy, investors take their dividend checks and put them in the bank regardless of whether they need all the proceeds to fund their lifestyle until their next round of dividends.
Smart investors know that, to give any investment strategy the best chance of success, you need to invest in it as much as possible and take out as little as possible. If you are getting dividend checks that are larger than your current needs, reinvest the excess so you give your future gains an extra boost over time.
Make sure that you’ve minimized your monthly budget, so that your needs are as small as possible; and forego spending any additional income you receive, instead trading unnecessary spending for additional future security.
Mistake #4: Misjudging your financial need
Many people rush into dividend investing, thinking that it can replace their regular paycheck. They fail to run the numbers, or aren’t conservative in their figures, and mistakenly think that dividend payments alone will cover their costs of living.
Typically, this results from either underestimating expenses or overestimating dividend income. To avoid this potentially hazardous pitfall, be sure that you are carefully considering your future needs – these will be the demands you place on the strategy. By purposefully setting the bar high, you increase the odds that your results will stack up.
Mistake #5: Misusing a dividend strategy
Many people are drawn to various investment strategies, thinking that they’re a good fit when that isn’t the case. There is nothing more dangerous that using a strategy when it’s not appropriate; when it’s not suitable for your situation.
To avoid this potentially dangerous misstep, it’s important to make sure that you have first taken a comprehensive look at your full financial situation – your personal balance sheet, cash flow requirements, etc. You also need to ensure that you are abundantly aware of the tenets of dividend investing, know exactly what it can and can’t do for you, and what’s required to use the strategy properly.
Mistake #6: Trying to do it on your own
Most investors need some kind of guidance. Even if it’s just a second set of eyes looking at the research you’ve done on various companies, to ensure that you’re focused on the right figures and not missing anything, two heads are better than one.
To help with the complexities of dividend investing, many people enlist the help of an advisor who is qualified to help guide them. Others rely on close friends or family.
Whoever you choose to help you, be sure that they are willing and able to focus on your needs and objectives, and to put your interests ahead of their own. Obviously, it’s impossible for anyone to predict the future, especially for specific companies. However, more knowledge is always better when dealing with sophisticated investing strategies.
This is anything but a comprehensive list of the potential mistakes that people can make when employing a dividend investing strategy. There are plenty of additional, unforeseen pitfalls along the way.
Investors should know they’re sailing through rocky waters. Hopefully the points above will help you see some of the most glaring potential hazards.
As always, it’s recommended that you enlist the help of a professional to help you navigate these dangerous waters. Surely, you will learn far more as you progress, and encounter additional obstacles. Hopefully you will identify other potential hazards before they cause you any trouble.
But hopefully you are also now also better equipped for – or at least more aware of – the dangers you may face, and how you can reduce some of the risks that any investor faces.