Living within your means and saving money each month is always a great habit.
In the long run, it can help to improve your financial position, and help you to bring forward your retirement.
However, with interest rates hovering at low levels presently, it’s tough to eke out a decent return when your money is parked in bank accounts.
The return that is offered by cash savings is disappointing when compared to the yield offered by other assets such as stocks and bonds.
As such, it may be possible to generate a larger nest egg by investing your savings.
Here’s why dividend stocks could be worth buying so that you can enjoy a higher overall return over the long term.
Inflation
Inflation is set to rise next year, pushing the prices of goods and services higher.
Already, Singapore is experiencing its highest inflation rate in eight years, clocking in at 3.2% in October.
We are experiencing it first hand.
Higher electricity prices are expected early next year as soaring global energy costs push prices up to record levels.
Meanwhile, property tax is also slated to increase for most HDB owners as the government revises the annual value of homes upwards by 4% to 6%.
The return on cash savings may lack appeal when you factor in inflation.
In fact, your buying power may be diminished.
In contrast, it is possible to build a portfolio of stocks that offer inflation-beating returns today.
It’s likely that this portfolio of dividend stocks can easily outperform the returns on cash savings over time.
Growing your stream of passive income
Not only can dividend stocks help you to beat inflation, but there is also the prospect of dividend growth moving forward.
If the business is growing and resilient to economic shocks, it can continue to deliver a healthy and consistent stream of passive income for you.
And over time, there is a high chance that this stream can grow if the business carries on doing well.
There are many examples of companies that have paid out increasing dividends for years or even decades.
Consumer giant Procter & Gamble (NYSE: PG) has increased its dividends for 65 consecutive years.
And Kimberly Clark (NYSE: KMB), well-known for its napkins, diapers and tissues, has increased its dividend for 49 consecutive years.
So, investing in the right companies and holding on to them can help you to achieve dividend growth over the years.
The beauty of compounding
Another powerful aspect of investing in dividend stocks is the ability for you to compound your dividends to enjoy even more dividends.
Compounding involves taking the money from your dividends and using it to purchase the very same stocks that paid out those dividends.
That way, you can slowly increase your stakes in these high-quality, cash-rich businesses and receive even more dividends in the future.
And it becomes a double bonus when the companies also jack up their dividends, as you get to enjoy even more passive income from such a move.
Albert Einstein is said to have remarked that “compounding is the eighth wonder of the world”.
At The Smart Investor, we agree with his observation, as compounding can not only boost your dividend income stream, but also help you to attain financial freedom sooner.
Get Smart: Understanding the risks
While investing in dividend stocks means there is some risk of capital loss, the risk to reward ratio appears to favour investors rather than savers.
With the world’s major indices having long track records of successful recoveries from bear markets, long-term investors who are able to adopt a buy-and-hold strategy should be able to enjoy high returns.
However, the outlook for savers appears to be somewhat downbeat as bank deposit rates continue to languish.
As such, investing any excess savings will prove to be a worthwhile move.
If you’re nervous, confused, or worried about buying your first stock, then our latest beginner’s guide to investing can help. It’s easy to read yet packed with valuable insights. Download it for free today, and buy your first stock in the next few hours. Click here to get started.
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Disclaimer: Royston Yang does not own any of the companies mentioned.
