Is Investing in Dividend Stocks Worth It?
A Deep Dive for New Investors
Hello everyone, and welcome back to another post from DualEdge Invest! Let’s dive into dividends: what makes them a favorite for some and a 'no-go' for others? Our loyal readers (all five of you – but hey, quality over quantity!) might remember that we recently tackled one aspect of capital allocation with our post on share buybacks. So, it felt only right to now dig into the alternative approach: dividends.
Dividends are a bit of a hot topic, with strong opinions on both sides. As always, our goal is to cut through the noise and show that there’s more to this discussion than simple pros and cons. There’s no black-and-white answer to whether dividend stocks are the way to go – but by the end of this post, we hope you’ll have a clearer picture of how dividends might (or might not) fit into your strategy.
Dividends 101
Let’s keep this brief, as dividends are actually a pretty straightforward topic. We’ll focus on two main aspects: what dividends are and how some investors build their entire strategy around them. Dividends may seem like just a regular payout, but for many investors, they’re a key part of a consistent, long-term income strategy.
Dividends are simply put a portion of a company's earnings distributed to shareholders as a way of sharing profits. It’s typically paid out on a regular schedule, such as quarterly or yearly, and serves as a reward for investors.
Because you own (a portion of) the company, you’re entitled to a proportionate share of its profits. However, these profits aren’t always paid out as dividends. Many companies, especially those in growth phases, choose to reinvest earnings back into the business to fuel expansion and, hopefully, increase future profits. In contrast, more established companies often opt to return a larger share of their profits to shareholders in the form of dividends, providing a steady income stream for investors.
And that steady income stream is precisely one of the biggest incentives for certain investors to build their strategy around dividends. Alongside rental income from real estate, dividends are considered one of the primary ways to generate passive income. The goal of this strategy is to establish a stable, passive income flow by investing in stocks that offer reliable and consistent dividend payments.
Now that we’ve got the basics down, let’s dive into the fun part. There are plenty of myths and assumptions about dividend investing—some of them more colorful than accurate—that we’re excited to break down for you.
The Case For and Against Dividend Stocks
We've already mentioned that the passive income generated by dividends attracts investors. So, we’re kicking off our analysis to see if living off dividends is truly a worthwhile strategy.
A Path to Freedom or Just a Fantasy?
For many, the dream is to stop working and still have enough money to live comfortably. Dividends can be an appealing way to reach that goal. In many countries, dividends are taxed at a lower rate than regular income, meaning you can potentially meet your income needs with a lower gross amount. However, it’s essential to check if this tax benefit applies in your own location.
That said, there are a few caveats to this “dream.” First, you’d need a substantial portfolio to live solely off dividend income. For instance, if we assume an average dividend yield of 4% per year and take Belgium as an example (where we’re based), the average household requires around €35,000 annually to maintain a comfortable lifestyle. To meet this with dividends, you’d need a portfolio worth approximately €875,000. That’s a significant sum!
You might also question whether dividend stocks are the best way to build such a portfolio. It could make more sense to prioritize growth-focused investments until you’ve accumulated enough, only then shifting to dividend stocks. Additionally, your portfolio's growth may be limited if you're constantly withdrawing dividends as income, as this reduces the reinvestment that fuels compounding.
We caution small investors against the idea of solely relying on dividends to replace their income. For most people, it’s not realistically achievable. Be skeptical of online voices pushing this idea without considering the full picture. A more attainable approach is to view dividends as a way to supplement your primary income. Boosting your monthly income by, say, €250 with dividends is more realistic. To achieve that with a 4% yield, you’d need a portfolio of around €75,000. While this still requires long-term dedication, it’s within reach for many with patience and discipline.
While dividends can offer a valuable income stream, they’re often promoted as more than just a source of extra cash flow. Many see dividend stocks as a 'defensive' investment choice, suggesting they provide stability and protection during turbulent markets due to their generally lower volatility and the stability of the companies behind them. But is this reputation fully deserved? Let’s take a closer look to see if dividend stocks really live up to their “defensive” label.
The Defensive Dividend Debate
If you ask investors what types of companies are typically considered dividend stocks, the most common answer you'll hear is: mature companies in well-established sectors.
In general, this perception is accurate, and there are several reasons for it. Investors tend to expect dividends to be paid consistently each year without cuts, and companies that reduce their dividends are often heavily penalized by the stock market. To meet these expectations, a company needs to maintain stable, reliable profits—a trait more commonly found in mature businesses.
Additionally, mature companies often generate more cash than they can productively reinvest into high-return projects. For example, if a potential acquisition yields only a 5% annual return while the company’s cost of capital is 8%, it would actually destroy value. In such cases, returning excess cash to shareholders through dividends is more attractive, as it’s a value-neutral transaction.
These companies are found in sectors labeled as established markets. This term refers to markets that are stable, mature, and relatively predictable. It means that the sector or country where the market operates has achieved a certain level of growth and development and is no longer subject to the rapid growth or significant fluctuations characteristic of emerging markets. Investors and companies often view established markets as safer because they carry less risk and are typically marked by reliable regulations, strong infrastructure, and mature consumer bases. Typical examples where you find dividend stocks include:
Real Estate: In established markets, real estate is generally a stable investment, although it can still be somewhat sensitive to economic cycles.
Consumer Staples: This sector tends to remain stable, as its products are essential and in continuous demand, even during economic downturns.
Utilities: These companies provide services that maintain consistent demand, as they deliver essential utilities that people need daily.
Each of these sectors embodies the characteristics of established markets, offering investors greater stability and predictable income through dividends and we agree with that statement. But we also believe there is another side to consider. The defensive nature of these investments, while appealing for risk-averse investors, may not always be as advantageous as it seems.
As we mentioned, companies that cut their dividends often face a swift and harsh reaction from the stock market. That’s why it’s essential for these payouts to be built on a foundation of sustainable earnings. In other words, a company needs not only the ability to maintain its dividend over the long haul but ideally to grow it as well. Crucially, these dividends should be backed by solid operating cash flows—not by debt or fleeting, one-time gains.
Although dividend stocks are typically seen as safe havens, they’re not immune to economic turbulence. A downturn can still shrink profits, force dividend cuts, or in extreme cases, even push companies into bankruptcy.
Then there’s the impact of rising interest rates. As bonds and savings accounts become more attractive in a higher-rate environment, dividend stocks can lose some of their luster. Higher interest rates also mean steeper financing costs, which is particularly troubling for real estate companies with debt-heavy balance sheets.
And let’s not forget inflation—a silent killer of margins. When costs rise sharply and companies can’t pass those increases on to consumers, profits get squeezed, putting even the most dependable dividends under pressure.
Don't be swayed by common investor assumptions or low volatility (read here to see why volatility doesn’t equal risk). Remember, many risks are specific to individual companies; consistent earnings and healthy debt levels are essential factors not to overlook. We'll be posting more soon on what we value most when analyzing dividend stocks. Yes, we research dividend stocks too—here’s why.
How we view Dividend Stocks
During our research on this topic, we learned a lot about dividend stocks. First, generating passive income through dividends requires significant time and discipline. It also seems challenging to rely on it entirely, especially when starting from scratch. A strategy focused solely on dividend stocks seems suitable only for wealthy investors who choose to prioritize income over growth.
This isn’t just because we find it unrealistic for small, beginner investors to live off dividends alone. We also consider it risky to invest all your funds in one type of company—namely, mature companies. For those aiming for a diversified portfolio (which we believe 99% of investors should), diversification shouldn’t only be geographical and sector-based, but also include companies at various stages of growth. It’s better to own both early-stage and mature companies. We’ll dive deeper into the topic of diversification in an upcoming post, so stay tuned!
And yet, we also invest in a dividend stock. This might seem surprising after our critical points, but there’s one particular sector we wanted exposure to where the dividend model fits perfectly: real estate. The real estate sector, especially REITs, is unique within the stock market. We believe that within this sector, you can earn consistent income and, with well-timed entry, potentially capture capital gains as well. This is just the tip of the iceberg; you’ll have to catch our next post to see our full findings!
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Please note: This article includes a disclaimer regarding investment advice.