Investing can be broadly split into two categories – growth investing, and income investing.
Just ask a random group of investors and most will fit into either type, while some may claim to be a hybrid of both styles.
Growth investing emphasizes steady capital appreciation through the rise in the share prices of the underlying securities.
Income investing, on the other hand, focuses on receiving a stream of passive income through dividends.
Dividend-paying stocks have a reputation for being slow, boring businesses without much growth.
However, I believe dividend stocks should form a core part of any investor’s portfolio. Here’s why.
The ability to pay a dividend
Stocks with the ability to pay a dividend imply that they have financial strength.
Only profitable companies can pay dividends as these payments cannot be made if a business incurs losses.
These companies also need to have reasonably sturdy balance sheets and generate healthy free cash flows to afford dividend payments.
Just take a glance at Singapore’s blue-chip index, the Straits Times Index (SGX: ^STI).
The 10 largest companies within the bellwether index all pay out dividends, and together, they make up more than 70% of the index’s total weight.
Hence, the search for a dividend-paying company means you are looking for one with stable and reliable financial characteristics.
A tangible return on your investment
Next, dividends represent money in your pocket and are a tangible return on your investment.
Capital gains, on the other hand, are reliant on the movement of share prices and are subject to volatility and short-term sentiment.
But when you receive a dividend, you can immediately book its yield as a real return on your investment.
Put another way, dividends provide you with a return that cannot be erased by the stock market’s wild mood swings.
And with the dividends in hand, you can also choose how you want to allocate the money.
You could spend it on a delicious meal, go on a short holiday, or even reinvest the cash into the same dividend-paying stocks to receive even more dividends.
Turning on the passive income tap
It’s no secret that a stream of dividends can prepare you better for retirement.
While you are young, you can still work and earn income from your job or profession.
As you age, you may eventually wish to stop working to enjoy your golden years in comfort.
Dividends are the flow of passive income that can help to supplement your earned income and provide you with the lifestyle that you enjoy.
While many people may rely on their CPF Life payouts, this amount may not be sufficient to provide you with your desired lifestyle.
Hence, there is a need to look for other sources of passive income.
These can include dividend-paying companies such as VICOM Limited (SGX: WJP) or Boustead Singapore Limited (SGX: F9D) or REITs such as Mapletree Logistics Trust (SGX: M44U) or Suntec REIT (SGX: T82U).
The magic of compounding
Finally, dividends allow you to enjoy the magic of compounding.
Through the passage of time and diligent reinvestment of your dividends, you can grow not just the value of your investment portfolio but also increase your flow of passive income.
There are a few ways to go about doing so.
Some REITs, such as Mapletree Industrial Trust (SGX: ME8U), offer a scrip option for unitholders to receive their distributions in new units rather than cash.
By accepting your dividend in units, you will enjoy a higher overall dividend the next time distribution is declared, assuming a constant level of dividend per unit is declared.
Back in 2020, the Monetary Authority of Singapore had limited the dividend payments from the local banks DBS Group (SGX: D05), OCBC Ltd (SGX: O39) and United Overseas Bank Ltd (SGX: U11).
All three banks then doled out scrip dividends as recommended by the central bank, and an investor could choose scrip to increase his or her shareholdings over time.
A third method would be to deploy your cash dividends to buy more dividend-paying stocks or REITs to slowly but steadily increase both your shareholdings and the dividends they pay out.
Get Smart: The allure of dividends
The above is a laundry list of why dividend stocks make such attractive investments.
We can add one more benefit to this already-long list – the ability of such stocks to beat inflation over the long run.
So, what are you waiting for?
Start adding some dividend stocks into your portfolio right now to experience the joy of receiving some passive income in your bank account.
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Disclaimer: Royston Yang owns shares of VICOM, Suntec REIT, Mapletree Industrial Trust, DBS Group and Boustead Singapore Limited.