What is Dividend Investing: In today’s dynamic world, depending on one source of income makes life financially difficult. The rising cost of living, inflation, and price hikes have affected everyone.
Basic commodities and consumer goods have been rising in prices and this has been a continuing trend across the world. If you’re still depending only on one active income for your livelihood, then you are missing out on the huge potential to earn while you sleep.
One of the ways to earn passive income is through the stock market. In the stock market, a new investor can benefit from capital appreciation of their investments and receive a payout from the company’s profits.
Capital appreciation is the increase in the value of your investment. The payout you receive from a company’s profits is called a dividend. Today we’re going to talk about what is dividend investing and how you too can use this concept to earn from your investments.
What is Dividend Investing?
Investing in stocks that pay dividends on their profits to their shareholders is called dividend investing. The focus is to invest in stocks that grow in value and pay regular profits to their shareholders.
Let’s try to understand dividend investing through an example.
Assume that you have made an investment in ABC Company. You bought 1000 shares at 100 rupees each. At the end of the financial year, ABC company declared a dividend of 6 rupees per share. That means your dividend was 1000 multiplied by a dividend of Rs.6 = 6000 rupees. Your ROI was 6% from the investment in company ABC.
Advantages of Dividend Investing
1. Duality of Dividend Investing
Apart from the capital appreciation of your shares, you also receive a passive income from your investments. Large Cap companies enjoy this privilege, especially after declaring profits. This is the dual advantage of dividend investing.
2. Passive Income
One of the major advantages of holding onto your investments is receiving a regular payout from your shares in public companies. The dividend is decided by the board of directors based on the company’s performance for that fiscal year. When a company publicly declares profits, the value of the share also increases as investors view the stock as a favorable investment.
3. Reinvestment
When a company declares profits and decides to payout dividends to shareholders, they have the option of either taking the cash or reinvesting it back into the company. This is a particular advantage for investors who have a comparatively smaller stake in the company.
4. Earnings Irrespective of Market Conditions
Dividends serve steady returns even in times of unstable market conditions. When Capital appreciation of stocks is unlikely, gains from holding stocks can be a safer bet. Market volatility is less impactful on large-cap companies.
5. Long-Term Investments
Buying and holding shares of established companies that provide consistent returns and have a capital appreciation of their assets is a safer investment. This is especially true for investors looking to retire in the near future.
ALSO READ: What is Earnings Per Share? Definition, Importance & More!
Disadvantages of Dividend Investing
1. Taxation
Dividends are liable to tax and the responsibility of paying taxes shifted to the shareholders as of 2020 in India. The normal rate of TDS is 10% on dividend income paid in excess of Rs 5,000 from a company.
2. Less Potential for Higher Returns
While they carry a lower risk than other forms of investing, returns are lower and growth is slower as well. This is due to the fact that the public companies already have an established market presence so there is less room for expansion to major cities and different market segments.
3. High Dividend Payout Illusion
A company that is offloading a majority of its profits to investors is often viewed as a good sign. However, by issuing a majority of their profits, there are lesser funds for expansion, projects, and reinvestments. This could mean that in the near future, the profitability will not be adequate to retain shareholders. Lack of growth in turn leads to a decrease in its share value and tougher competition.
4. Dividend Cuts
Paying dividends from the common stock of a company is not an obligation to shareholders. So there are chances that a company may decide to slash dividends because of lower performance, debts and loans, loss-making years, etc. Other reasons could also be funding and expansion. This could also affect share prices and could serve as a double negative as both share price and dividend drop simultaneously.
Points To Consider In Terms of Dividend Investing
Investing in dividends, after doing dedicated research, can reap multifold rewards. This is especially true if you have long-term investment goals and the patience to wait for your returns.
However, there are also drawbacks to investing in dividends as mentioned above. They are less at risk compared to other investment instruments but also have their own set of disadvantages as well. Do consider both factors to help you make the right decision for your portfolio.
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