Last Updated on 21 November, 2023 by Samuelsson
Can you lose money on dividend stocks? Can dividend stocks lose value?
Quite an obvious answer to this question would be yes, you can lose money on dividend stocks – as is the case with any investment. Stock picking is difficult. DIY investors need to construct a properly diversified dividend portfolio and simultaneously overcome the investment biases we all have within.
Thus, it’s easy to pick the wrong stocks. Most dividend investors should rather buy mutual funds and sell shares to get income. Furthermore, how many dividend stocks should you own? To avoid losing money on dividend stocks, you should own many stocks – at least 20.
In a world that changes with the passing minute, nothing is certain. Dividend stocks are no exception to that rule and sometimes fall in value. Apart from the many factors that influence the returns that come from investments, it’s in the hands of the investor to analyze and choose the right stock along with building the right strategies.
But the whole concept of investing in dividend stocks may get motivated for the wrong reason. Misconceptions can get built up in many investors. Don’t get fooled by your dividend bias.
The most common are investors thinking of dividend stocks as coupons. A dividend is a distribution that comes directly from the company’s earnings. But a company doesn’t need to pay them. They choose to pay.
A company, on the other hand, can also choose not to pay and reinvest the funds back into their business as retained earnings for further growth and future projects with potentially higher returns.
However, we also find companies that pay dividends regardless of any decrease in profits to keep a regular track record of dividend payouts.
Don’t focus on the dividend, focus on the total return
In many cases while investing in dividend stocks, investors tend to forget the concept of total returns. Their focus lies more on their cash account.
That’s where compounding enters, which means investing the dividend payout into the company to buy more shares and increase your total earnings.
The entire point lies in evaluating the stock you plan to invest in, not just by its dividend payout history but also by the sectors it belongs to, potential growth, etc.
Misconceptions about dividend investing
As mentioned above, the uncertainty that comes with the ever-changing world, there is only so much one can do about it. And at times, there are factors that we have no power over.
So what one can do is learn how to avoid the risks or the least, minimize them and clear out the common misconceptions that can actually cost you money while investing in dividend stocks.
High Dividend Yield
One of the biggest misconceptions about investing in dividend stocks is considering high yield as king. But to many investors’ surprise, a high yield is not always a good thing, and there are many reasons behind it.
Following this misconception, investors tend to choose a collection of the highest dividend-paying stocks and just sit and hope for the best. For many reasons, this is not a good idea.
If you go on to screen the companies with the highest dividend yield, you will come to notice that even though they were the best in terms of dividend yield, their total return was hardly impressive.
Moreover, it is crucial to remember that a dividend is a percentage of a company’s profit that it is paying its shareholders in cash, formally quoted as its payout ratio.
But the back end of the story is that every penny that the company is paying out as dividends is every penny they are not reinvesting in themselves. So when a business is significantly paying a higher percentage of its profits, it could mean its management hesitates to reinvest in the company.
That’s why investors are advised to watch out for the dividend payout ratio, which measures the profit percentage going out to the shareholders because it becomes a key metric for an investor to analyze the flexibility to reinvest and grow their earnings.
A company that can reinvest the earnings back into the business grows faster than if you were to DRIP:
Choose the right industry for your dividend stocks
In a bid to choose the highest profit-making dividends and the business that is issuing them, sometimes investors skip out on the broader aspect of the situation. Keeping in check with the trends and evaluating the stocks based on them is critical to constructing a future with improved and integrated returns.
Choosing stocks based on industry and sector trends goes a long way while investing in dividend stocks because it helps pick more profitable stocks and ensures that the company’s potential growth becomes an imperative part of the process.
Moreover, it helps skip out on companies more prone to dividend cuts.
Healthcare, for instance, is a great example of a sector that is strong enough to take a few hits when the market plunges. Such a sector’s behavior creates a steady and consistent increase in dividend payouts with time.
It is also important to keep in mind that trends are capable of changing as time passes. Take the example of soft drinks. Investing in the soft drinks industry is generally considered a strong bet.
But as people grow more accustomed to the idea of taking care of their health, which they are now, consumers can potentially lose trust in the consumption of the product altogether.
Hence it is essential for investors to identify and consider these checkpoints that come with the changing sector trends while committing their money.
Hendrik Bessembinder wrote a paper in 2017 with a lot of press coverage: Do Stocks Outperform Treasury Bills? The shocking result of the study is that just very few stocks manage to outperform short-term Treasuries over the long term.
Moreover, most surveys show a grim result of the abilities of the small retail investor: on average they underperform the indices substantially.
Dividend investor or not, the odds of beating the market are not great.
So what should you do? Don’t put all your eggs in one basket, and make sure you additionally have some holdings in mutual funds, perhaps both active and passive funds. Make sure you have done proper research before you invest.
Can you lose money on dividend stocks? Conclusion
Dividend investing poses great opportunities for investors, and indulging in them can be highly profitable. But it is crucial to understand the process of evaluating them.
When it comes to making or losing money in dividend stocks, it is based on an investor’s skills to pick out stocks (and sometimes luck). There are often situations that influence stock and the market that investors have no control over.
Diversification is what one should keep in mind. Don’t put all your eggs in one basket. Diversifying the risks away helps create a strong portfolio that can get you quite a passive income later in time.
And most important, evaluate your tolerance for risks. Before jumping into investing, one should realize how much they can invest in research about the stocks they are planning to put their money in, how much risk they can take, and, more importantly, how much they can invest.
It is advised for investors not to go far out of their comfort zone and knowledge base. Make sure you understand the components that influence returns and avoid unnecessary risks.
At the end of the day, yes, you can lose money on dividend stocks. Instead of doing it yourself, you should consider buying ETFs and mutual funds.
– How can I minimize the risk of losing money on dividend stocks?
To reduce the risk of losing money on dividend stocks, consider diversifying your portfolio by owning many stocks, at least 20, and evaluate your tolerance for risks.
– Why might investors get motivated for the wrong reasons to invest in dividend stocks?
Some investors may be motivated for the wrong reasons, building misconceptions about dividend stocks. It’s crucial to invest with the right mindset and understanding.
– What is a common misconception about dividend stocks?
A common misconception is thinking of dividend stocks as coupons. While dividends come from a company’s earnings, a company can choose not to pay them and reinvest in the business for future growth.