What is Dividend?
Dividend is a form of money paid to the shareholders by a company. Companies that have extra profit left after deducting all the expenses if they do not need it, they would be paid out as dividend to its shareholders.
However, every company has its own way on how to allocate their financial resources either to pay out as dividends or to further expand its business to generate more value toward its shareholders.
Why are Dividends Important?
Dividends allow you to generate cash flow without the need to sell the stock. However, to make superior profits through dividends, you have to understand the concept of compounding.
When you received dividends, you have the choice either to spend it or reinvest them. If you choose the latter by reinvesting the dividends, you will have more stocks which in turn, pays you more dividends. By consistently reinvesting these dividends, you will then experience compounding effect on your net worth.
So, here are 3 reasons why you should invest in dividend stocks:
Reason #1 – Multiple Income Streams
The idea of having multiple income streams is wonderful. By doing this, it allows you to have financial flexibility. The more cash you have coming in, the more options you have – in terms of lifestyle. This income stream is none other than dividends. Imagine having invested in established businesses that provide you with constant streams of dividend incomes.
By consistently generating multiple streams of dividend from various companies, it helps you to improve your cash flow. Dividend stocks have proven to generate cash flow and for as long as you hold on to your stock, you can trust that you will receive your dividends on time every year like clockwork.
Dividends are paid either yearly, half-yearly, quarterly or in some rare cases, monthly depending on the company’s structure. Due to the single tier tax structure, the dividends paid in Malaysia, Singapore, and Hong Kong are tax exempted.
Let’s move on to the 2nd reason on how dividends will be built up overtime and allow time for your dividends to grow.
Reason #2 - Hedge against Potential Risk
In the stock market, the presence of risk is inevitable because market trends are unpredictable. Yet funny enough, many try to do so. Men can hardly predict their wives’ feelings let alone predict the market. As wise investors, we may not be able to eliminate risk, but we can certainly reduce our exposure to it by investing in great dividend companies.
This is because a company can only pay out consistent dividends when it has regular streams of earnings and great dividend companies such as blue chips dividend companies are typically more mature and stable in earnings compared to the average ones. In other words, they are cash-rich! Not only do these companies have predictable cash flow, they also have the tendency to withstand down markets than ordinary businesses, preventing permanent loss of capital. With that, they are less volatile relative to the market and helps support long term investing.
Apart from that, dividends can also be used to offset losses. When a stock falls by 3% in price, holding a 7% dividend yield stock would give you a 4% profit on your investment, indirectly minimizing your investment risk.
However, do beware that not all high dividend yield companies are stable companies. In some cases, these companies can be a misleading trickery as companies lure investors into investing by giving out high dividends even though the company is suffering from huge losses or high debts.
Reason #3 – Compounding Miracle on Reinvested Dividend
The miracle of compounding is a gift, those who use it can yield the most incredible profit one could ever imagine. This concept is best described with an example. The difference between reinvested and not reinvested dividend is utterly fascinating.
Let’s say you had invested RM 10,000 in a fund that yields 7% dividend per annum. Instead of reinvesting your yearly dividend, you decided to spend it. During the 10 years, you will consistently be receiving RM700 every year and your dividend yield would still remain 7% yearly. Not only that, your investment would still remain RM 10,000 after 10 years.
On the other hand, if you had reinvested your yearly dividend, your result will improve significantly.
Notice that by reinvesting dividends, your yearly dividend yield is no longer RM700 but increasing exponentially as the years go by. Similar to your investment capital, it begins to grow exponentially instead of remaining the same at RM10,000. Here is the interesting part, because of the exponential growth in your investment capital within the 10-year period, your average yearly dividend return is no longer 7% annually but rather increased to 9.67% annually. If extended over a period of 30 years, the yield increases exponentially over time.
A well-planned compounding strategy will benefit the power of exponential growth. Through dividend reinvestment, your original investment will produce greater returns. The longer you reinvest your dividend, the more quickly your returns will multiply.
In summary, building wealth through the stock market is simple but not easy. The issue lies in human nature, being impatience, setting unrealistic expectations, and taking advice from the wrong people that have different financial goals and time frame than you.
But investing in dividend growth stocks can help you to avoid these pitfalls because these investments can help you to see your portfolio as not just a collection of digital symbols and randomly changing numbers on a computer screen, but real pieces of quality business, a tangible cut of global corporate profits.
This is how regular people can achieve an increase in income and wealth that lead to financial independence through investing in a dividend stock. Those who diligently exploit the benefits of dividends will eventually see to yield the result of his effort. As the saying goes, “those who sow with tears will reap with songs of joy.”
Disclaimer: All facts and opinions presented are for educational purposes only. This is not a recommendation to buy or to sell. The author involved in the writing of this message has no vested interest in the companies. Please consult a professional for expert financial or other assistance or legal advice.