One of the best investment strategies is investing in dividend paying stocks. While stocks are riskier than bonds, if chosen carefully they can be a lot more profitable than bonds and non-dividend paying stocks.
The reason is that if an investor enrolls in a dividend reinvestment program dividends that are paid by the company are used to buy more shares which will result in a higher dividend next time around. The process of reinvesting interest or in this case dividends leads to more money growing faster with each passing payment period. This is known as compounding and is a very powerful thing when it comes to increasing a person’s wealth over the years. The more time an investment can compound safely the better. It takes the same amount of time for an investment of $1,000 to grow to $10,000 than for $10,000 to $100,000. That is the magic of compounding.
Another benefit of investing in dividend paying stocks is that shares can go up in value in addition to the money received as dividends. Let’s imagine that a person invests around $2000 and buys 100 shares for $20 each of “X” company and waits 5 years before selling the shares. In this example we will assume that the person enrolled in a dividend reinvestment program and that after five years he or she ended up with 120 shares. If the price of the shares remained the same that person would go home with $2400. Now let’s assume that the company is well managed and that the board of directors approved a share repurchase program and that as a result shares went up $10 during the period to $30. The same initial investment of $2000 would have turned into $3600 ($30 x 120 shares = $3600) a noticeable difference.
So does this mean that if a stock does not pay dividends is not a good investment? The answer is no. Businesses that do not pay dividends can also turn up to be good investments. Many of these companies prefer to expand operations or reinvest earnings acquiring other businesses. As the fair value and assets of the company increases so does the price of the stock. Legendary investor Warren Buffett’s Berkshire Hathaway has only paid one dividend and it has made many investors millionaires including Warren himself who is one of the worlds wealthiest. Still, a good reliable dividend works as cushion if the price of the stock goes lower and the reinvested dividends make up for any loss of principal. They can also serve as a good source of passive income to the investor if he or she needs that money to take care of other things in life.
As you can see there is a lot of money to be made by investing in dividend stocks. With proper research and the advice of a good broker you can have your own dividend portfolio compounding for your retirement or to pay for your children’s education when the time comes.