A well-balanced investment portfolio includes near-cash investments, fixed-income securities, as well as domestic and foreign equity. Sometimes when people hear the word equity, they panic because they associate equity with risk. However, there are degrees of risk when purchasing equity investments, and not all equity investments have very high risk.
Different types of equity investments include stocks, precious metals, mutual funds and a variety of dividend-paying investments. As a financial planner, one of the most frequent questions that I am asked by clients -- other than 'Can you please increase my credit card limit?' -- is this:
Question: How can I start making money from dividends?
Answer: My answer to clients is always the same -- generating income from dividends is very simple. You just have to find the right type of dividend-paying investment for your personal investing strategy.
Let's look at the three most common options.
But first, I want to say that while dividend-paying investments can be a key part of a well-balanced investment portfolio, putting all of your money into dividend-paying investments is never a good strategy.
Dividend-payers can be a low-risk option for the domestic and foreign equity portion of your investment portfolio. It's still a good idea to have some fixed income -- for example, bonds and near-cash investments, such as T-bills -- to round out a diversified investment strategy.
Before purchasing a new type of investment, check if it is right for you. Investing is a very personal decision, and there is no one investment strategy that fits the masses. If you have a more conservative personality, you may want to put your money in low-risk investments. If you like to live on the edge a bit more, you may want to put your money into higher risk investments.
That said, dividend-paying investments are a very real option. And there are three types you should consider:
Stock prices fluctuate on a daily basis, and dividends are usually paid out on a quarterly or annual basis to shareholders by companies who have made a profit.
When you buy stocks of a company, you may hope to buy them at a low price and sell them at a higher price for a capital gain. Many investors who purchase dividend-paying stocks prefer the security of having a regular dividend payout over a capital gain. (This is exactly what my colleague Amy Calistri shares with readers of The Daily Paycheck each month. She has come up with a three-pronged formula that allows her and her readers to safely earn a second income.)
If you prefer to purchase individual stocks, buying preferred shares may be the way to go. Preferred shares are regular shares in a company with preferential dividend payouts and voting rights.
We say that investing in preferred shares is low risk because you are purchasing shares of big companies that have a history of making a profit. Yes, of course, there is some risk involved when investing in stock, but investing in well-known companies definitely brings lower risk than investing in startups.
Dividend Mutual Funds
A dividend is paid out as a dollar amount per share unit. For example, if a shareholder owns 100 shares and the company pays out $2 per share, then the shareholder will receive a $200 dividend. If you don't want to use all of your money to buy one type of stock, you can purchase the stock of several different companies through a dividend mutual fund.
Mutual funds are pooled investments. This means investors put all of their money into one mutual fund and the fund manager buys stocks of companies that are aligned with the mutual fund's goals. If you are new to the world of dividends, purchasing dividend mutual funds is a great way to learn about the risks associated with investing in stocks.