Too Many Dividend Investors Are Ignoring This Problem...

posted on 06-07-2019

This week, a client wanted me to tell him which dividend stock is the best to buy.

He said his retired neighbor receives a large portion of his income from stocks that pay out dividends, and having seen that, my client wanted to get in on the dividend action, too.

Adding to the allure, his neighbor told him that it doesn’t matter how much the actual stock price increases or decreases because his dividend payout (aka his income) will always remain the same.

This is a tempting -- and true -- statement, but I'm going to tell you why you shouldn't get sucked in.

First, let me tell you a little more about my client.

My client is not yet retired, but he wants to be. He figures that if he can make a lot of money from investing in dividend stocks, he can have a steady income just like his neighbor. However, as I told my client, the best dividend stock depends on what he wants the stock to do for him, how much income he is hoping to receive and how much risk he is willing to take.

Meanwhile, it's true that the dividend payout of a stock should remain the same or close to the same regardless of how the actual stock price changes on a daily basis.

The quarterly or annual dividend is paid out on a per-share basis. Someone who owns 500 shares in a company will receive the same dividend amount per share as a person who owns 10 shares in the same company.

But here is why you shouldn't be tempted by this fact:

What my client failed to understand was that the daily price change in the value of his dividend stock was his own capital investment gaining or losing. Even though a client can receive regular dividend payouts, it’s still important to know the value of your capital investment... no one wants to lose their own money. The dividend payout is an added bonus when investing in stock; the gain or loss on the capital investment is still a very important aspect of your profit.

Let’s say that my client invested $100,000 to buy 1,500 shares of a dividend stock that paid out a quarterly dividend of $1.50 per share. This means that my client purchased the dividend stock at $66.67 per share and is expected to receive $2,250 each quarter from a dividend payout.

If the dividend stock price falls to $60 per share, my client will continue to receive his $2,250 dividend payout per quarter because the payout is based on the number of shares, not the value per share. However, his capital investment of $100,000 is now only worth $90,000. 

Even with the quarterly dividend payout my client is not recouping his initial investment; not only is he not making any money, he is actually losing money. This is why it is very important to understand the risks involved when investing in dividend stocks.

The Investing Answer: Tracking your investment values through your online banking and regular paper statements are good ways to keep up to date on the value of your capital investment. You can track the daily change in the value of your stock online through websites such as Yahoo Finance.

If the daily fluctuations in the value of your dividend stock make you nervous, then maybe investing in stock is too risky for you.  If you want to receive a regular income stream from your investment portfolio then maybe fixed income investments such as income mutual funds or bonds are a better option for you.  Fixed income investments can provide a regular monthly income and the investment risk is generally lower than investing in dividend stocks.

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