In an article published earlier this month, I explained how I invest the money within my Stocks and Shares ISA. To recap, I invest around 60% of my capital in FTSE dividend stocks (with a strong focus on companies growing their dividends) and the remaining 40% in growth companies listed both in the UK and internationally.
Here, I’ll look at some of the reasons why I invest the majority of my ISA money in dividend stocks.
Passive income
The first reason is I like the passive income they provide. With dividend stocks, I get paid a second income stream for doing absolutely nothing, irrespective of what the stock market is doing. My ultimate goal is to build an income stream from dividend stocks (tax-free within the ISA) that I can retire on.
Financial flexibility
Next, I enjoy the financial flexibility dividends provide. When I receive a cash dividend it gives me options. I can spend the cash if I want to, or I can reinvest it. Currently, I reinvest all my dividends. However, it’s nice to know that if I needed some extra cash flow for some reason, I could turn to my dividend income.
More certain returns
I also like the fact dividend payments are quite a reliable source of investment returns (although they’re not guaranteed). Compared to capital gains, which are highly uncertain, there’s more certainty of a return. In finance, this is known as the ‘bird in the hand’ theory (i.e. a bird in the hand is worth two in the bush).
Two sources of profit
Another benefit of dividend stocks is that they provide me with two potential ways to profit – from the dividends received and also from capital gains. This is particularly advantageous when stock prices are falling. Dividends also take a lot of the stress out of investing as you can profit without having to constantly buy and sell.
Strong performance
Research also suggests dividend-paying companies (particularly those that consistently increase their dividends) tend to generate excellent returns over time. For example, a study by analysts at Ned Davis Research found that between 31 January 1972 and 31 December 2018, dividend-paying companies in the S&P 500 index outperformed non-dividend-paying companies by a wide margin.
Compounding power
I’ll also point out that dividends stocks enable me to take advantage of one of the most powerful forces in investing – compounding. By reinvesting my dividends, I can buy more shares which, in turn, gets me more dividends for the future.
Portfolio stability
Finally, dividend stocks tend to be less volatile than growth stocks, as dividend-payers are generally well-established companies that have strong balance sheets and reliable cash flows and profits. This, in theory, means my portfolio is likely to fall less during a bear market, which provides peace of mind.
Overall, there are many advantages to investing in dividend stocks. In my overview, it’s a simple, yet effective, way of investing for the future.
